EPA 230/1-74-038
August, 1974
          ECONOMIC ANALYSIS
                     OF
   PROPOSED EFFLUENT GUIDELINES
     ANIMAL FEED, BREAKFAST CEREAL AND WHEAT STARCH
     SEGMENTS OF THE GRAIN MILLS POINT SOURCE CATEGORY
                     QUANTITY
       U.S. ENVIRONMENTAL PROTECTION AGENCY
            Office of Planning and Evaluation
                Washington, D.C. 2O460

-------
   This document will subsequently be available
through the National Technical Information Service,
            Springfield,  Virginia  22151

-------
EPA 230/1-74-038
August, 1974
                                FINAL REPORT
       ECONOMIC ANALYSIS OF PROPOSED EFFLUENT GUIDELINES FOR
          ANIMAL FEED, BREAKFAST CEREAL AND WHEAT STARCH
          SEGMENTS OF THE GRAIN MILLS POINT SOURCE CATEGORY
                                Samuel G. Unger
                              Robert!.  Buzenberg
                                Alan H. Ringleb
                         ^.vixownontal Protection Agency
                         Region V, Library
                         2"-) ?-->-vth Dsarbo'rn Street:
                                 Illinois 606G*       .;
                                  Prepared for
                        Office of Planning and Evaluation
                        Environmental Protection Agency
                            Washington, D.  C.  20460
                            Contract No. 68-01-1533
                              Task Order No. 13

-------
                                   PREFACE
       The attached document is a contractor's study prepared for the Office
       of Planning and Evaluation of the Environmental Protection Agency
       ("EPA").  The purpose of the study is to analyze the economic impact             '
       which could result from  the application of alternative effluent limitation           j
       guidelines and standards of performance to be established under sections          '
       304(b) and 306 of the Federal Water Pollution Control Act,  as amended.           |

       The study supplements the technical study ("EPA Development Document")
       supporting the issuance  of proposed regulations  under sections 304(b) and          :
       306.  The Development Document surveys existing and potential waste             '
       treatment control methods and technology within particular industrial
       source categories and supports proposal of certain effluent limitation
       guidelines and standards of performance based upon an analysis of the
       feasibility of these guidelines and standards in accordance  with the require-
       ments of sections 304(b) and 306 of the Act.   Presented in the Development
       Document are the investment and operating costs associated with various
       alternative control and treatment technolpgies.  The attached document
       supplements this analysis by estimating the  broader economic effects
       which might result from the required application of various control
       methods and technologies.  This study investigates  the effect of alter-
"^     native approaches in terms of  producf price increases, effects upon em-
 ^     ployment and the continued viability of affected plants, effects upon
\^     foreign trade  and other competitive effects.
\
       The study has been prepared with the supervision and review of the Office
       of Planning and Evaluation of EPA.  This  report was submitted in fulfill-
 J     ment of Contract No. 68-01-1533,  Task Order No. 13 by Development
• *'     Planning and  Research Associates, Inc. Work was completed as  of
       July, 1974.

        This report is being released and circulated at approximately the same
        time as publication in the Federal Register  of a notice of proposed rule
        making under sections 304 (b) and 306 of thV&ct for the subject point
        source category.  The study is not an official EPA publication.  It will
        be considered along with the information contained in the Development
        Document and any comments received by EPA on either document before
        or during proposed rule making proceedings, necessary to establish final
        regulations.  Prior to final promulgation of regulations, the accompanying
        study shall have standing in any EPA proceeding or court proceeding only
        to the extent that it represents the views of the contractor  who studied
        the subject industry.  It cannot be cited, referenced, or represented in
        any respect in any such proceeding as a statement of EPA" s  views regarding
        the subject industry.

-------
                           CONTENTS

                                                               Page

      PREFACE                                                i

      EXECUTIVE SUMMARY                                   1

J.     INDUSTRY SEGMENTS                                    1-1
           A.  Cereal Breakfast Food Segment                  1-3
                     1.   Types of Firms                        1-3
                     2.   Types  of Plants by Segment            1-7
                     3.   Number of Plants  and Employment     1-9
                     4.   Relationship of Segments to Total
                           Industry                             I-10
                     5.   Likely Impacted Segments              I-11
           B.   Wheat Starch Processing Segment                1-11
                     1.   Types  of'Firms                       1-12
                     2.   Types  of Plants                       1-14
                     3.   Number of Plants  and Employment     1-15
                     4-   Relationship pf Segment to Total
                           Industry                             1-15
                     5.   Likely Impacted Segments              1-16

H.    FINANCIAL PROFILES                                    II-1
           A.   Cereal Breakfast Food Segment                  H-l
                     1.   Plants by Segment                    II-1
                     2.   Distribution of Data                    11-11
                     3.   Ability to Finance New Investment      11-13
           B.   Wlieat Starch Processing Segment                H-14
                     1.   Plants by Segment                    n-15
                     2.   Distribution of Data                    11-21
                     3.   Ability to France New Investment      11-21

in.   PRICING
           A.   Price Determination     , ,-                      TII-1
                     1.   Cereal Breakfast Food Segment        T"-l
                     2.   Wheat Starch Processing Segment      III-3
           B.   Potential Price Change3                         HI-5

IV.   ECONOMIC IMPACT ANALYSIS METHODOLOGY           IV-1
           A.   Fundamental  Methodology                       IV-1
                     1.   Returns                               IV-5
                     2.   Investment                            IV-6
                     3.   Cost of Capital - After Tax            IV-7
                     4.   Construction of the Cash Flow          IV-8
           B.   Pric-j Effects                                   IV-9
           C.   Shutdown Analysis                              IV-11
           D.   Production Effects                              IV-12
           E.   Employment Effects                             IV-12

-------
                       CONTENTS  (Continued)

                                                               Page

IV.  (Cont'd)
           F.   Community Effects                             IV-12
           G.   Other Effects                                   IV-12

V.    POLLUTION CONTROL REQUIREMENTS AND COSTS      V-l
           A.   Pollution Control Requirements                 V-l
                     1.  Ready-to-eat Cereal Manufacturing    V-3
                     2.  Wheat Starch and Gluten Manufacturing V-5
           B.   "Typical1' Effluent Control Costs                 V-6

VI.   IMPACT ANALYSIS                                       VI-1
           A.   Cereal Breakfast Food Segment                 VI-2
                     1.  Price Effects                          VI-2
                     2.  Financial Effects                      VI-4
                     3.  NSPS Effects                          VI-12
                     4.  Other Effects                          VI-12
           B.   Wheat Starch Processing Segment               VI-12
                     1.  Price Effects                          VI-15
                     2.  Financial Effects                      VI-17
                     3.  NSPS Effects                          VI-24
                     4.  Other Effects                          VI-27

VII.   LIMITS OF THE ANALYSIS                                VH-1
           A.   General Accuracy                              VII-1
                     1.  Errors in Data                        VII-2
           B.   Current State of Waste Water  Treatment
                  in the Industry                               VII-4

-------
              ECONOMIC ANALYSIS OF PROPOSED
                    EFFLUENT GUIDELINES
                               FOR
   ANIMAL FEED, BREAKFAST CEREAL AND WHEAT STARCH
                 SEGMENT OF THE GRAIN MILLS
                   POINT SOURCE CATEGORY
                      EXECUTIVE SUMMARY
The economic impacts of proposed point source effluent guidelines on
three grain mill products industry segments were assessed in this study:
(1)  Cereal Breakfast Food,  (2) Wheat Starch Processing,  and (3) Animal
Feeds. The following brief summary highlights the purposes, procedures,
and findings which are developed in detail in the final report.
BACKGROUND
The primary purpose of this study was tp analyze the potential economic
impacts of proposed pollution abatement  requirements on each of the three
above named industrial segments.  Specific focus was placed on the analysis
of probable price effects,  financial effects,  production effects, employment
effects  and community effects which ^re  expected following implementation
of proposed point source effluent control guidelines.

This study was completed  pursuant to the Federal Water Pollution Control
Act Amendment of  1972.  Implementation of this Act, as amended,  requires
that regulations for the control of effluents from industrial point sources
be  developed and that effluent guidelines  be established to meet Federal
clean water standards.  The guidelines for the industry segments of this
study have been proposed in a  separate development document. _!'   Prior
to the imposition of such guidelines,  however,  an evaluation was necessary
of various economic impacts on the industry segments and the  national
economy.

The study and final report were prepared under the supervision and review
of the Office of Planning and Evaluation pf the U.S. Environmental  Pro-
tection  Agency (EPA) by Development Planning and Research Associates,
Inc. (DPRA).
—  Development Document for Proposed Effluent Limitations Guidelines
   and New Source Performance Standards for the Animal Feed, Breakfast
   Cereal and Wheat Starch Segment of the Grain Mills Point Source
   Category, Sverdrup & Parcel and Associates,  Inc.,  April,  1974.

                                1

-------
SUMMARY AND CONCLUSIONS

In each of the segments, it is emphasized that most existing plants are
currently discharging their wastes into municipal treatment systems.
The  guidelines proposed herein do not apply to such plants directly.
Hence,  even in the case of wheat starch processing, the economic im-
pacts are quite limited on  an industry-wide basis when considering only
the point source category guidelines  of this study.

For  the three industry segments studied,  potential  impacts of the pro-
posed effluent regulations  ranged widely from virtually "no impact" on
the animal feeds  segment to probable closure  of "model"  plants with
direct discharge  in the wheat starch segment unless prices are increased
substantially.  (About a 5 percent increase in  composite wheat starch-
gluten prices was projected, and this reduces  the likelihood of potential
plant closures in the wheat starch  segment.)

A  related and growing concern to these segments is prospective changes
in municipal treatment standards and increased  costs to industrial users.
In some instances, management personnel of plants which are  currently
on municipal systems are  seriously evaluating pretreatment systems
and/or  private treatment systems  •which might lower their overall treat-
ment costs.  Future  outlooks  for these industry segments are conditioned
by prospective industry-wide treatment requirements and costs as well as
the proposed point source  category requirements.  Because of the pre-
dominance of municipal treatment  of wastes, the price and production
effects  reported in this study are difficult to quantify.   That is, pass-
through of higher treatment costs to consumers  via higher prices are
expected to be  constrained by that  portion of the industry on municipal
systems.  In general, it is unlikely that plants with direct discharges
will recover full costs of pollution controls, and for some plants (especially
in wheat starch processing) plant closures and/or barriers-to-entry for
new plants with prevalent  technology would be expected.
SYNOPSIS OF REPORT

The analysis of impacts and findings of the study as developed in the final
report are as briefly outlined below.  This summary is presented by
major section in the same order as contained in the final report.

-------
                      I.   Industry Segments
The three grain mill products industry segments analyzed were as
follows:
       SIC 2043 - Cereal Breakfast Food.  This segment is com-
       prised of three basic types of cereal preparations: ready-
       to-eat (RTE),  hot cooked and natural breakfast foods.  Only
       the RTE subsegment required detailed analysis because  the
       others have no process waste waters that require treatment.

       SIC 2046 - Wheat Starch Processing.  Water effluents are a major
       problem for this  portion of the SIC 2046 industry (corn wet
       milling).  Improved technology in the industry will reduce
       effluent problems,  but existing plants are threatened by the
       proposed controls.  Estimated treatment costs are relatively
       high for existing  plants or new sources which would employ
       prevalent technology.

       SIC 2048 - Animal Feeds.  The economic impacts of proposed
       water effluent controls on this industry segment are negligible.
       Process waste waters are insignificant; water use is primarily
       for steam generation and cooling.  Non-contact process wastes
       are not subject to the proposed guidelines, and consequently
       the conclusion of "no impact" was reached.  No further  analysis
       was required in the final report.

For the reasons given, only two segments were analyzed in detail in the
report: cereal breakfast food and wheat starch processing.

A.   Cereal Breakfast Food Segment

The cereal breakfast  food industry in total was  comprised of  26 firms
which operated 47 plants in 1974.  Of this total,  17 plants were RTE
plants  (three other plants were combination RTE-hot cooked cereal
plants  which would also have process waste waters).

Plant sizes within the RTE subsegment range widely from under 200, 000
to over 1,000,000 pounds per day.  Representative model plants of
200,000 Ibs/day, 500,000 Ibs/day and 1,200,000 Ibs/day were analyzed
in detail in the study in order to assess differential impacts by  plant size.

-------
The firms in the cereal industry are widely diversified,  principally
into other food processing activities.  Leading firms in cereal manu-
facture,  e.g.,  Kelloggs,  General Foods (Post),  General Mills, Quaker
Oats, are among the nation's largest companies, and their operations
are international in scope.  Plants within the U.S. are located in six-
teen states, although there is some concentration of plants in the North
Central region.

The cereal breakfast food industry has been a growth industry. Em-
ployment in 1972 was estimated at 12,800,  up from 12, 200 in 1967.
Value of shipments from  this segment are over $1 billion per year,
and it is a leading economic segment within the grain mill products
industry. The greatest growth in production and sales in the recent
past has been with  RTE and natural cereal breakfast foods.  Only the
RTE subsegment has process water effluents requiring treatment,
however.
 B.  Wheat Starch Processing Segment

 An important aspect of this industry is that two main products are manu-
 factured:  wheat starch and vital wheat gluten.  The latter high-protein
 product (constituting only 14 percent of the raw material flour input) is
 an important,  high valued ingredient in the baking industry and more  re-
 cently in the manufacture of texturized vegetable  protein products. About
 half of the value of sales of the industry is in the  gluten products.  Hence,
 the industry might more  accurately be called the  wheat starch-gluten
 industry.

 This grain mill products industry segment is relatively small with only
 7 plants currently operated by 6 firms.  Also, 2 new plants are under
 construction--but these new plants have introduced major technological
 changes.  Also, the two  new plants were primarily constructed to manu-
 facture vital wheat gluten which is in short supply.  (No plans are reported
 for additional  construction of plants with prevalent technology.)

 Wheat starch plants are  typically affiliated with much larger grain null
 products firms, especially flour milling companies,  e.g., General Mills,
 Centennial Mills, Pillsbury.  (These plants utilize "second  clears" and
 low grade flours from flour mills as raw material input for further pro-
 cessing).  Plants are located predominately in wheat producing areas,
 and usually near  (adjacent to) flour mills.  Existing plants are relatively

-------
old,  and until recently, the numbers of plants have steadily declined.
Also, the new plants are regarded as new-types of plants and, hence,
strict comparisons are not applicable.

Existing plant sizes range narrowly from about 750 to 1, 500 hundred-
weight (cwt) of flour processed per day.  A single representative model
plant with 1,000 cwt/day capacity is  used in the detailed analysis to
depict this industry segment.  Employment in the industry is estimated
at about  150 (excluding new plants) and value of shipments are currently
about $17 million per year.  While this segment is small in comparison
to other  industry segments, the products produced are important inter-
mediate  products for other food processing and manufacturing industries.

Wheat starch processing requires  large amounts  of water for processing,
and thus water effluent regulations' are of major concern to  the indudsty
even though all but one plant currently discharges into municipal systems.
Regardless of their existing treatment practices,  this segment is con-
cerned about future, more  stringent  pollution controls.
                      II.  Financial Profiles
Within this section of the study the primary areas  of interest include
industry profitability,  capital structure,  cost and availability of capital,
pro forma income statements, invested capital and the cost structure of
model plants by segment.  Much of the information requested by EPA
was not generally available for these industry segments.  Considerable
emphasis and reliance on model plant estimates by DPRA was necessary
in order to complete this section.  Such information was critical for the
impact analysis which follows  in section  VI, below.
A.   Cereal Breakfast Food Segment

The  cereal breakfast food industry has generally been a very profitable
industry in the recent past.  Reported net profits of major cereal com-
panies have ranged from  about 8 to 21 as a percent of net worth, with
about a 15 percent average.  Net returns on sales  have  ranged from less
than 2 percent to over 8 percent, averaging near 4 percent.  These data
represent total corporate earnings which only partially  reflects cereal
plant operations.  It is estimated that RTE cereal plants are relatively
more profitable than is shown in consolidated earnings reports.

-------
A major underlying financial characteristic of the RTE subsegment is
its capital structure.  This subsegment is  quite capital intensive, with
per plant investments (including working capital) ranging from about
$15 million to $75 million for the three model plants  analyzed in this
study.  (RTE plants are normally much larger than either hot cooked
or natural breakfast food plants.) Most of the major cereal companies
have been established for many years, and their reported fixed debt to
net worth ratios are generally low.  This factor strengthens the capital
availability position of the industry if additional capital from external
sources is required.

Based on model plant  pro forma income statements which were developed
for this  study,  the RTE  model plants have  estimated returns on sales
from about 11 to 13 percent. This  rate of return is relatively high, and
a critical assumption in the model plant analysis is the budgeted expendi-
tures for marketing and sales  costs. For example,  estimated  indirect
costs for these functions represented about 18 percent of sales. Major
expenditures for advertising and promotion have been a  trademark  of .
the cereal industry, and a characteristic of the packaged food industry
in general.  An individual plant or company could vary considerably
from this budgeted level for marketing and sales in relative terms.
(A further aspect of this industry is an emphasis toward maintaining
market shares, which in turn makes market entry difficult for  new
fi rm s.)

Semi-detailed cost structures for the model plants are shown in the re-
port.  Due to the emphasis of this industry toward marketing and sales
programs, and its capital intensiveness (plus rather extensive  ware-
housing-distribution systems), actual raw materials costs (for oats,
corn,  wheat, rice,  etc.) are relatively low in relation to sales, i.e.,
about 20 to 22 percent.  This ratio is less than  most other food pro-
cessing industries where raw materials costs are  generally much
higher in relation to sales.

Due to the financial strength of the cereal breakfast  food industr"   the
companies in the industry are not expected to have major difficu   \i
acquiring additional capital for pollution controls.  The firms also have
a strong cash flow position due both to turnover in sales and to depreci-
ation allowances which are sizeable in capital intensive industries.

-------
B.   Wheat Starch Processing Segment

The financial characteristics of wheat starch processing plants are ex-
ceptionally difficult to ascertain from consolidated financial statments
of their parent grain milling firms.  In many cases, average industry
statistics for grain milling firms were used as surrogates for this seg-
ment.  Also, however, engineering cost  synthesis methods were used to
develop a "typical" model plant of 1,000  cwt/day.  Much of the financial
data presented are derived from simulated operation of the model plant.

Historically, grain mill products firms have had net profit to sales
ratios  of about 3 percent and net worth to sales ratios of about  10 per-
cent.  These rates of return are generally less than the averages for
all manufacturing industries.  The model plant financial data were com-
parable to these industry data,  i.e.,  net income  to sales  ratio  of 3.9
percent.  This estimate was based on a pro forma income statement
and financial return analysis of the selected model plant.

Capital investment requirements for the  wheat starch model plant were
estimated at slightly over $1 million, including working capital on a re-
placement cost basis for a prevalent technology plant.  Most plants
using old technology have been in operation for some time and the finan-
cial returns shown were based on estimated book values.  In this case,
the return on invested capital was about  13 percent for the plant.  (For
the new plants with improved technology, capital investment require-
ments  are reportedly much higher, but not known in detail.  Also,  oper-
ating data are not yet available,  so a financial analysis could not be de-
veloped. )

On an  annualized cost basis,  the cost structure of the model wheat starch
plant is dominated by the cost of raw materials,  i.e. , low grade flour,
which  represented about 80 percent of total sales.  This ratio is gener-
ally high for the grain mill products industry.  Marketing and sales costs
are minimal in that sales are direct to industrial buyers — both starch
and gluten products are intermediate products which are further pro-
cessed by other manufacturing industries. There is essentially no differ-
entiation of products among firms nor promotion of products in public
media.

The  ability to finance new investment in  the wheat starch processing in-
dustry is  limited based on the financial strength of the wheat starch plant
alone.   However,  the affiliation of these  plants with larger,  diversified
firms  would enhance their position for acquiring moderate levels of
additional capital if continued operations were economically feasible.

-------
                          III.   Pricing
The price determination processes (demand/supply conditions) both in
the cereal breakfast food and the wheat starch processing industries
are described in this section.  Each segment is quite distinct with
respect to marketing and price determination mechanisms.

A.  Cereal Breakfast Food Segment

Packaged cereal breakfast foods  are geared for delivery and sale pri-
marily to retail consumer  markets.  Consequently, these goods are pre-
pared and packed for such  markets at the processing plant,  regardless
of whether  intermediate wholesalers, jobbers or other distributors
become involved in the marketing-distribution chain.  Any marketing-
promotion programs  geared  to a  particular product line are also norm-
ally coordinated from the processor level.

Besides the three basic types of cereal plants as identified,  the industry
as a whole  produces many  breakfast cereal products within each sub-
segment.  In many instances product forms are similar, but different!-  •
able,  and they are marketed in varying package sizes.   In the  last 20
years over 150 cereal brands have been produced.

Ready-to-eat cereals, which are generally produced from one or more
of the basic grains--corn,  oats,  wheat  and rice, maybe flaked, puffed,
extruded, or shredded.  Also,  these cereals may be coated  or non-
coated with sprays of sugar,  vitamins,  minerals, etc.  to fortify and/or
sweeten the product.   Many new products, especially breakfast cereals
with relatively higher protein content, have recently been introduced.

In general terms,  no more than 4 percent of the total crop of oats,  wheat,
corn,  rice  or barley  are used for cereal production.  Hence, the in-
dustry is neither constrained by nor dominantly influences these basic
commodities markets.

A characteristic of the cereal breakfast food industry has been its aggress-
ive advertising and sales promotion programs. To promote consumer
preference for individual product brands,  cereal makers on average are
reported to spend  about 13 percent of their cereal sales revenue for ad-
vertising.  In a related matter,  Federal Trade Commission action is
currently pending  against the four leading cereal companies charging
these firms with having a shared monopoly with over 90 percent of the
ready-to-eat cereal markets in the U.S.  It is claimed by FTC that in-
dustry practices have resulted in artificially inflated prices, excessive

-------
profits, limitations on product innovation,  and a general lessening of
competition.  The outcome of these FTC charges could affect the future
structure of the industry.

Based on data developed for this study,  it is clear only that marketing
and sales costs are generally high for all firms  studied.  Emphasis is
placed on market share goals which principally entails varied forms of
non-price competition. A new firm might  readily establish production
capability,  but market penetration would undoubtedly be difficult in this
long established market where company and brand loyalties do exist.
A natural market behavior in such an industry is to seek to maintain
company  and brand loyalties with non-price forms of competition.

The  proposed point source effluent controls are not expected  to directly
alter prices of products.   Also,  any affected plants should not be dis-
located due to the proposed guidelines.

B.   Wheat  Starch Processing Segment

In extreme  contrast with  the cereal industry,  wheat starch processing
involves the manufacture of essentially undifferentiated products (both
starch and gluten).  Further, these products are sold principally to in-
dustrial buyers by private treaty arrangements, and there is essentially
no advertising or promotion expenditures in public media.

As a result of this market  structure, there is minimal indirect expense
for marketing and sales and related administrative overhead costs.  As
was  depicted in the model plant financial profiles, an exceptionally high
proportion of the total costs of operation are attributed to raw materials
costs, e.g., about 80 percent of the total sales  revenue.   A major in-
fluence on prices is simply the cost of commodities,  i.e.,  wheat, and
associated flour milling costs.

Also, however, starch and gluten sales are made to  essentially distinct
markets.  Wheat starch sales (mainly to the paper industry)  compete
directly with other industrial starches (predominantly corn starch) and
little can be done by wheat starch processors to independently make
cost/price adjustments in these  markets.  Wheat starch suppliers are
basically "price takers" in starch markets.

Vital wheat gluten (primarily for use in baking and texturized vegetable
protein manufacture) has almost opposite market characteristics from
wheat starch.  In this case, there are no close substitutes and gluten
products  are in short  supply in growing world markets (the U.S. im-
ports about 40 percent of its current needs, and world competition for

-------
available supplies has been increasing).  The main opportunities for
recovering higher pollution control costs would be via gluten product
price increases.  (It is also noted that the new plants are designed to
improve the production and yield of vital wheat gluten products which
will affect long-run supply response  patterns of this industry.)

Although price increases are not expected directly due to the proposed
point  source guidelines because of their limited applicability for existing
plants,  the industry as a whole is anticipating higher waste treatment
costs regardless of their current arrangements.   This expectation re-
sults  in projected price increases which would apply to new sources  and/
or plants which might discontinue municipal treatment services.  A
composite price (revenue) increase of about five  percent was projected.
           IV.   Economic Impact Analysis Methodology
As implied in the foregoing discussion, the primary methodology for
assessing  expected economic impacts for each of the segments studied
was  to develop and analyze representative model plants.  That is,
financial and operating characteristics of hypothetical but representative
plants were simulated for purposes of this study.

The  core analysis for this study was based upon engineering-economic
synthesis both of physical and financial characteristics of representative
(model)  plants in each of tne industry segments.  Where necessary,
various  types of sensitivity analyses were performed to reflect potentially
relevant differences among existing plants, e.g., size,  age,  technology
and  other physical or economic conditions. Such procedures are regularly
used in pre-investment feasibility analysis by industry; and while no single
operation is precisely simulated,  this type of analysis can  be used to in-
dicate approximate and relative effects of add-on pollution  control treat-
ment practices.  Both pre- and post-treatment analyses were performed
to determine incremental as well as aggregate economic  impacts.

Industry-wide  impacts were estimated based on extrapolation of n.o^jl
plant effects to all affected plants  in the industry segment.  Economic
information external to an individual  plant was also required in order
to project industry-wide  effects.  Both commonly accepted microeconomic
and  macroeconomic factors and procedures were utilized to interpret and
extend representative model plant results.
                                10

-------
The main analyses performed were designed to examine a series of
specific effects such as price,  financial, production,  employment,
community and balance of trade effects.  Underlying procedures
used are explained in the final report and they are not repeated in detail
here.  A schematic of the overall methodological steps utilized in the
impact analysis for each  segment is shown in Figure  IV-1 of the final
report.

One of the main impact assessments of this study involved probable
plant closures.  In some  cases it is not likely that a plant would make
major  capital investments in an old plant if price increases sufficient
to recover such investments were not possible.  The  analysis developed
to assess this issue was referred to as the net present value analysis.
In brief, this analysis was used to estimate expected long-term net re-
turns if the  business were continued vs.  salvaging the plant and re-
investing residual funds in other activities  (an opportunity cost princi-
ple).  To compare these alternatives, all expected future returns were
discounted at the cost of capital rate to present values.  A net present
value of less than zero in the current business would imply that plant
closure would be expected.  These and other procedures are covered
in detail in  the final report.
           V.  Pollution Control Requirements and Costs
 The water pollution control standards, technology, and costs used in
 this analysis were furnished by the Effluent Guidelines Division of EPA
 from materials developed in part for the Agency by Sverdrup and Parcel
 and Associates (S&P).  The basic  data constructed by S&P were  adapted
 to the types and sizes of plants designated in this analysis.

 Three effluent guidelines were considered:

        BPT    -     Best Practicably Control Technology Currently
                      Available, to be achieved by July 1, 1977

        BAT    -     Best Available Pollution Contr  1 Technology
                      Economically Achievable,  to be achieved by
                      July 1,  1983

        NSPS    -     New Source Performance Standards,  apply to
                      any source for which construction starts after
                      the  publication of the proposed regulations for
                      the  Standards

                                11

-------
Brief descriptions of the recommended technology (and estimated costs)
for achieving the three guidelines in each segment were presented in
non-technigal terms in this report.  However, to avoid duplication and
possible confusion, no technical descriptions of  BPT,  BAT and NSPS
guidelines were given. The interested reader is referred to EPA's
technical report for technology descriptions. A'

Also included in this  report are summaries  of each industry's  current
waste treatment practices and experiences with  waste treatment  con-
trols.  It is known that at least some firms in the wheat starch segment
are having difficulty in meeting the  proposed guidelines via transfer of
technology from other industries.  In other words,  the proposed  tech-
nology has not  yet been proven within this industry  segment.
                       VI.   Impact Analysis
The imposition of point source effluent guidelines on the ready-to-eat
cereal and the wheat starch processing industries are not expected to
result in significant direct impacts on either industry.  The principal
reason for this conclusion is simply that nearly all existing plants are
on municipal treatment systems.  Also,  pollutants  of these segments
are compatible with municipal waste treatment and the proposed Federal
regulations do not require that pretreatment be performed.  To illustrate
potential impacts, however,  model plant analyses were completed.
Furthermore, new sources into these segments are affected if they  should
directly discharge into surface waters.

New source performance standards (NSPS) are comparable to the pro-
posed BAT guidelines and the costs for BAT control are applied to hy-
pothetical new source model plants in both industry segments.  In the
wheat starch industry the proposed guidelines would result in a probable
barrier to entry for plants which would employ prevalent technology.
In the cereal breakfast food industry the  proposed guidelines would not
likely prohibit entry based on comparable types of financial analysis.

A.   Cereal Breakfast Food Segment

For all three sizes  of RTE cereal model plants, the proposed guidelines
would lower profitability and returns on investment.  Prices in the in-
dustry are not expected to be increased,  however,  because of the minimal
—  Development Document, Ibid.
                                 12

-------
applicability of the point source guidelines, i.e.,  those plants on
municipal systems would effectively determine prices even.though any
affected plants would incur increased costs representing about a .4
percent price increase for the medium sized model plant.

While profitability and returns on investment would be lowered,  any
impacted plants would not be expected to close,  nor would the estim-
ated control costs prohibit entry of a new plant.  The estimated treat-
ment costs  are extensive, e.g., about $875,000 for a medium sized
RTE plant,  but this level is not prohibitive in relation to basic capital
requirements of the RTE segment,  e. g. ,  about $34 million for the same
model plant.

Because plant closures are not expected,  and because prices are not
expected to increase due  to point source  guidelines, all other studied
effects are  projected to be negligible.  That is,  production would not
be reduced, and there should be no major employment dislocations or
community  impacts. In general, the RTE cereal  segment is  expected
to have  the  capacity to meet the proposed guidelines without significant
economic  dislocations either on individual plants  or on an industry-wide •
basis.

B.   Wheat  Starch Processing Segment

In this industry, only one plant currently discharges directly into surface
waters, but even then only after starch wastes are first utilized in a dis-
tillery operation.   (A treatment plant is under construction to treat the
distillery wastes.)  Another plant is expected to discontinue discharge
into a municipal system following completion of an on-site land disposal
system.  All other plants are on municipal systems.

Because of  the limited applicability of the proposed guidelines of this
study, the industry-wide  direct effects are expected to be minimal.  On
the other hand, the proposed regulations would result in severe impacts
on any affected plant, including new sources.  The impact analysis was
completed on the model plant case to illustrate the potential impacts which
could result.

Based on model plant analysis, two main potential impacts were as follows:
(1) An existing medium sized plant would require  about a  9 percent com-
posite price increase  (or 9 percent increase in sales revenue) in order to
recover the proposed incremental costs for pollution control, and (2)
a new source plant with prevalent technology would likely be prohibited
from entry  because of both the higher replacement cost for plant facilities
and the  relatively  high pollution control costs as shown in this study.

                                13

-------
A further assessment was made of the potential price pass-throughs
which may be expected within the wheat starch-gluten industry.  Demand
and supply prospects for starch and gluten products, especially vital
wheat gluten, are such that a 5 percent composite price  (sales) increase
was projected due to likely pollution control impacts on the industry as
a whole (involving mostly plants on municipal systems).

Existing plants might then recover sufficient costs to remain operative
if private treatment systems were needed but new sources using existing
technology would still not likely enter the industry.

The foregoing impact assessments were largely hypothetical based on
model plant analysis.  The purpose was to illustrate potential impacts on
either existing plants which might leave municipal treatment systems  or
new source plants.

In conclusion, because of the predominance of municipal hook-ups, overall
industry impacts of point source category guidelines should be minimal.
Production,  employment and balance  of trade factors should not be affected
and community effects  should be inconsequential.  As indicated, prices  of
wheat starch and gluten products are  likely to be increased by about 5 per-
cnet,  but primarily due to higher municipal treatment system costs.   Perhs
the main direct impact is that new source plants with prevalent technology
which directly discharge would be prohibited from entry due to the extensiv
cost burden of private treatment systems as  proposed.

An important further consideration in this  study, however, was that im-
proved technological processes to produce vital wheat gluten have been
introduced.  Such technology is expected to replace existing plant tech-
nology and, also, water emissions and control problems are greatly
reduced in new source  facilities. Such facilities will likely replace
existing plants over time.  In fact, two new plants with the new processes
are under consideration.
                    VII«   Limits of the Analysis
 The impact analysis presented was based upon data and information
 from industry sources, from published secondary data sources and
 from estimates prepared by DPRA.   Subjective judgments were also
 required. Naturally the analysis presented is limited to the accuracy
 of the data utilized.  Also, the analytical procedures employed require
 simplifying assumptions which are also subject to variability within a
 given industry.
                                14

-------
In this final section of the report,  DPRA presented its own assessment
of the reliability or general accuracy of the data utilized,  possible ranges
of errors in key data, and critical assumptions. In addition, selected
sensitivity analyses were performed to assess the relative importance
of key parameters,  e.g., price levels, cost of capital,  etc.

In particular, the most critical assumptions of this  study involved:
representativeness of the model plants, model plant cost data,  prices
and inflation,  and the cost of capital.   These limits  were described in
Chapter VII and the reader is referred to this section of the final report
for details.

Another limit to the analysis  involves the degree of  applicability of the
proposed guidelines within each industry segment.   A concluding  sub-
section of the report is a statement regarding the current  state of waste
water treatment in the industries studies.
                                 15

-------
              ECONOMIC ANALYSES OF PROPOSED
                    EFFLUENT GUIDELINES
                            FOR
   ANIMAL FEED, BREAKFAST CEREAL AND WHEAT STARCH
                SEGMENT OF THE GRAIN MILLS
                   POINT SOURCE CATEGORY
                   I.  INDUSTRY SEGMENTS
The economic impacts of proposed point source effluent guidelines have
been assessed in this study for three grain mill products industry seg-
ments:  (1) Cereal Breakfast Food - SIC 2043; (2) Wheat Starch Pro-
cessing - SIC 2046; and (3) Animal Feeds  - SIC 2048. 1J The economic
impacts expected vary widely both among  and within these three seg-
ments.  The  following synopsis outlines the basic impacts and explains
the general contents of this report:

SIC J043 -  Cereal Breakfast Food.  This segment includes three basic
       types  of cereal preparations:  ready-to-eat (RTE), hot cooked,
       and natural breakfast foods.  Only the RTE subsegment has
       process waste waters that require  treatment. Hence, this
       study focuses on the RTE subsegment of the industry.


SIC 2046 -  Wheat Starch Processing. L'  This industry segment repre-
       sents  only one part of the SIC 2046 (Wet Corn Milling) industry
       as defined by Census of Manufactures. It is a relatively minor
       industrial segment in SIC 2046 as well as the overall grain mill
       products industry, but water effluents are a major problem.
       Direct discharge treatment requirements are a serious  threat
       to the industry as it currently exists.
    SIC represents the Standard Industrial Classification code as used
    by the Census of Manufactures.

 _' Only wheat starch processing operations are discussed in this report.
    In a prior EPA study, the impacts on the corn wet milling segment of
    SIC 2046 were assessed, i.e.,  Economic Analysis of Proposed Effluent
    Guidelines for Selected  Grain Mill Products Industries, EPA-230/
    1-73-014, August 1973.
                                1-1

-------
SIC 2048 - Animal Feeds. —   The impacts of water effluent controls
       on this industry segment are negligible because process waste
       waters are virtually non-existent.  Water is primarily used
       for steam generation and cooling. Waste water emissions are
       limited to non-contact process wastes which are not subject
       to the guidelines proposed herein.  Consequently,  this in-
       dustry segment is not  studied in detail in this report due to
       a "no impact" status.  (Air  pollution control requirements
       are serious for the industry, but this study involves only
       water effluent controls.)

The following analysis and presentation is developed around the two
main segments indicated (RTE cereal preparations and wheat starch
processing). Within each of these primary segments, key subseg-
ments are also described.

In the original scope of work, another four-digit SIC code was proposed
for study: SIC 2047 (Dog,  Cat and Other Pet Foods).  However, signi-
ficant water effluent problems were encountered in neither the "dry"
and "semi-moist" pet  food segments.  Canned (wet) pet foods are ex-
pected to involve water effluents of consequence, but this segment
was  not a part of this study.
— A description of the industry and the reasons for excluding the in-
   dustry from further analysis are explained in the report: Develop-
   ment Document for Proposed Effluent  Limitations Guidelines and
   New Source Performance Standards for the Animal Feed, Break-
   fast Cereal and Wheat Starch Segment of the Grain Mills Point
   Source  Category,  Sverdrup & Parcel and A ssociates, Inc.,
   April,  D74.

                              1-2

-------
               A.   Cereal Breakfast Food Segment
The cereal breakfast food industry includes processing plants primarily
engaged in manufacturing breakfast cereal and related preparations.
Three types of cereal plants are commonly recognized within the industry:
(1) ready-to-eat (RTE), (2) hot cooked, and (3) natural breakfast cereals.

This study focuses on the RTE subsegment, which consists of 17 plants
(plus 3 combination RTE and hot cooked cereal plants) all having sub-
stantive process waste water emissions that require treatment.  The
remainder of the industry, hot cooked and natural breakfast cereal
plants, has insignificant processing waste water emissions.

j..  Types of Firms
                   Size and Number of Firms
The cereal breakfast food industry in total is currently comprised of
26 firms which operate 47 plants (see Table 1-1).  The  major firms in-
volved are among the largest food processing companies in the world,
e.g., Kelloggs, General Foods, General Mills, Quaker Oats, etc.
With the exception of a few firms, these companies generally represent
widely diversified operations, primarily in food processing; and, the
cereal breakfast foods portion of the companies' operations may not
necessarily be their dominant enterprise.  For example,  these  com-
panies also process  cake mixes, baby foods, pet foods, snack goods,
bakery goods, frozen foods as well as a wide variety of other food and
non-food items.

Cereal breakfast food  plants, per se, range widely in capacity from less
than 200,000 pounds per day to well over 1,000,000 pounds per  day.  The
largest plants, e.g.  , Kelloggs and Post, are commonly referred to as
super size plants.  Plant size data are  not completely available; however,
the smaller plant sizes are typically associated with the hot cooked and
the natural breakfast cereal operations. These plants would commonly
produce about 50,000 pounds per day.   In contrast, RTE plants  are larger
in general and  range widely in size throughout  the industry.  For example,
in this study,  representative RTE model plant  sizes are depicted as pro-
ducing 200, 000 Ibs/day, 500,000 Ibs/day and 1,200,000 Ibs/day. I/
—  Representative plant sizes for the RTE subsegment were developed in
   the Development Document,  Ibid.

                               1-3

-------
 Table 1-1.   Breakfast cereal industry firms and plant locations, 1973
The Kellogg Co.
Battle Creek,  Michigan  49016
Plants:   Battle Creek, Mich.
         Memphis, Tenn.
         Omaha,  Neb.
         San Leandro, Cal.

General  Foods-Post Division
Battle Creek,  Michigan  49016
Plant:    Battle Creek, Mich.

General  Mills
Minneapolis, Minnesota  55440
Plants:   Buffalo, New York
         S.  Chicago, HI.
         Toledo,  Ohio
         Lodi,  Calif.
         W. Chicago, HI.

The Quaker Oats Company
Chicago, Illinois  60654
Plants:   Cedar Rapids, Iowa
         Dannville,  111.
         St. Joseph, Mo.
         Shiremanstown,  Pa.

Nabisco, Inc.
New York,  N.  Y.  1002Z
Plants:  Minneapolis, Minn.
         Niagara Falls,  N. Y.
         Naperville, HI.
         Oakland, Calif.

Ralston  Purina Co.
St. Louis, Mo.   63188
Plants:  Battle Creek,  Mich.
         Cincinnati,  Ohio
         Davenport,  Iowa

International Multifoods
Minneapolis,  Minn.  55402
Plants:   Carrollton, Mich.
         Manhattan, Kans.
Baker/Beech-Nut
Canajoharie, N.  Y.  13317
Plant:  Canajoharie, N.  Y.

CPC International Inc.
Englewood Cliffs, N. J.   07632
Plant:  Buffalo, N.  Y.

Fisher Mills
Seattle, Washington 98134
Plant:  Seattle, Wash.

Fruen Milling
Minneapolis, Minn.  55405
Plant:  Minneapolis, Minn.

Gerber Products Company
Fremont, Mich.  49412
Plants:   Ft.  Smith,  Ark.
         Freemont,  Mich.
         Oakland, Calif.
         Rochester, N.  Y.

H. J. Heinz
Pittsburgh, Pa.  15230
Plant:   Pittsburgh, Pa.

H. C. Knoke &t Company
Chicago,  Illinois  60650
Plant: Chicago,  HI.

Larrowe Mills
Penn Yan, N. Y.   14577
Plant:   Penn Yan,  N.  7.

Little Crow Milling Co.
Warsaw,  Indiana   46580
Plant:   Warsaw, Ind.

Malt-O-Meal Co.
Northfield, Minnesota  55057
Plants:  Northfield, Minn.  (2)
         Stockton,  Cal.
                               1-4

-------
    Table I-l.   Breakfast cereal industry firms and plant locations, 1973 (cont'd)
National Bakers Services. Inc.
Broadview, Illinois
Plant:   Broadview,  111.

National Oats Co.
Cedar Rapids, Iowa  52402
Plant:   Cedar Rapid*, Iowa

Pet, Inc.
St.  Louis, Mo. 63166
Plant:   	, Michigan

Pillsbury Co.
S. Minneapolis, Minnesota 55402
Plant:   S. Minneapolis,  Minn.

Richard Foods Corporation
Melrose Park,  Illinois  60160
Plant:  Melrose Park, 111.
Reman Meal Co.
Tacoma, Washington 98411
Plant:   Fargo, N. O.

Standard Milling Co.
Kansas City, Mo.  64105
Plant:   Highspire, Pa.

Uncle Sam Breakfast
Omaha, Nebraska  68111
Plant:   Omaha, Neb.

Van Brode Milling Co.
Clinton,  Massachusetts 01510
Plant:   Clinton, Mass.

Colgate Pa 1molive  Co.
Chicago,  Illinois  60654
Plant:	, m.
                               1-5

-------
While detailed plant size data are not generally known, market shares
by company have been estimated. Within the cereal breakfast foods
industry,  the Kellogg Company easily dominates the U.S. cereal mar-
kets (and, also, world markets).  For example, Kellogg1 s market
share represents over 40 percent of the U.S. total. Market snares
of the major firms  in the industry in the early  1970's were approximately
as follows:
                                   Estimated
                                     Market        Number of
              FirmShare           Plants
      Kellogg                           43                 4
      General Mills                     18                 5
      General Foods (Post)              18                 1
      Quaker Oats                      11                 4
      Ralston Purina              )                        3
      International Multifoods      )	   5                 2
      Nabisco                     )                        *
      All Others                         5                24
          Total                        H«>                47
              Level of Integration and Diversification
The firms in the breakfast cereal industry are generally widely diversified
principally into other food processing activities.  However,  some compani
also have interests in many non-food items, e. g. , clothing, toys, pet food;

Furthermore,  the major cereal companies are active in international
markets (both in sales and increasingly in production within other countriei
Hence,  these companies are multi-national in scope.  The top seven cerea
companies are all listed in Fortunes  top 500 companies.  Ger  ml Foods
is the largest,  and it is currently 39th in rank.   Five additional cereal
processors are among the top 500 companies, but their cereal divisions
are relatively small compared to other types of manufacture.

Within this industry,  there is substantial horizontal integration as has
been noted.  Vertical integration is less apparent.  Firms competitively
purchase raw materials from the agricultural sector, although some
growers may produce commodities under contract with a particular
processor.

                                1-6

-------
Major cereal companies also tend to have sophisticated processor-
wholesaler-retailer marketing relationships, although direct owner-
ship of final marketing facilities is not a significant factor.  The large
cereal companies do typically maintain major warehousing-distribution
facilities  centered in consuming (vs. producing) areas; and this does
influence  their economic relationships  with customers.

2.   Types of Plants by Segment

This section includes information relative to type, size, location, age,
technology and efficiency of plants within the cereal breakfast food in-
dustry.  Breakfast food plants  vary in the type of breakfast cereal(s)
processed,  i.e.,  ready-to-eat, hot cooked,  and natural breakfast foods.
The known types of plants are indicated, by size category, in Table  1-2.
Both ready-to-eat (RTE) and hot cooked cereals are produced in several
plants as  shown.  Only the RTE plants  have  significant water effluents;
and, hence, the subsequent pollution control analysis is effectively
applicable to only these plants.  Cereal breakfast food plants are not
always strictly cereal breakfast food operations.  Most commonly,
similar items  such as snack foods,  cake mixes, and some pet  foods may
be processed in the same plant.  This  variation in processing affects
overall waste treatment requirements  and the impact of effluent limita-
tion guidelines.

Individual plant size data are generally not available (proprietary),  but
plant locations are as indicated in Table 1-1.  Also,  a summary of the
number of cereal breakfast food plants by state is as follows:
                   State                  No.  of Plants
                  Illinois                        7
                  New York                     6
                  Michigan                      6
                  California                     5
                  Minnesota                     5
                  Pennsylvania                  3
                  Iowa                          3
                  Nebraska                      2
                  Tennessee                     1
                  Missouri                      1
                  Kansas                        1
                  Washington                    1
                  Arkansas                      1
                  Indiana                        1
                  North Dakota                  1
                  Massachusetts                _ 1

                                               47

                                 1-7

-------
    Table 1-2.   Types of breakfast cereal plants by size category.
Type
Ready-to-eat (RTE)
Hot cooked
Both (RTE and hot cooked)
Natural
Unclassified

Small
7
12
1
6
— —
Size
Category—
Medium Large
8
--
2
2
• V
2
1
--
--
* ••

Total
17
13
3
8
6
                               26          12         3        47
—   Size categories: Small--50, 000 to 300, 000 pounds/day; Medium--
    300, 000 to  1, 000, 000 pounds/day; and Large (super sized)--over
    1, 000, 000 pounds/day.  Wide variability in size exists both among
    and with the types of plants shown.  The smaller plants within the
    small size  category are generally hot cooked or natural cereal
    plants.  RTE plants are usually larger in thruput volume within
    each size category.  In this study,  representative RTE plants  are
    estimated as follows:  small-200, 000 Ibs/day,  medium - 500,000
    Ibs/day, and large-1, 200 , 000 Ibs/day.  This subsegment is of
    primary concern in this study.

   Source: Estimated by DPRA based on discussions with industry
           representatives.
                                1-8

-------
 There is a wide dispersion in the geographic location of cereal processing
 plants. The greatest concentration of capacity is in the North Central
 region, but some plants exist in all regions of the U.S. (16 states overall).

 The age of plants is not generally meaningful in this industry.  Buildings
 may be quite old, but modern equipment and improved%technologies are
 usually employed.  Because of rather constant in-house replacement of
 equipment and modernization as needed, the industry is considered to be
 efficiently operated at the processing plant level. Expanded operations
 have  largely been in the "natural11 breakfast foods area, and quite
 modern facilities have generally been installed.

 3.  Number of Plants and Employment

 Plant numbers by type were as shown in Table 1-2 above.  There are
 no precise data available  concerning employment by plant in the cereal
 breakfast food industry.   Manpower requirements have therefore been
 estimated as follows for purposes of this analysis.

The cereal breakfast foods industry has been a growth industry in employ-
ment as well as output based on the 1972 Census of Manufactures prelimin-
ary report for SIC 2043. Estimated employment was 12,800 (all employees)
in  1972,  up from 12,200 in 1967 (an increase of 5  percent).   Production
workers were estimated as 10,800 in 1972,  which represented 84 percent
of  all employees.

DPRA  estimates employment per plant approximately as follows:

                                                 All Employees
                 \l          No. of           Ave. per
       Plant Size ~           Plants           Plant        Total

       Small                   32                  40      1,280

       Medium                 12                  310      3,720

       Large (super size)      	3_               2,600      7,800
                               47                          12,800
    Size categories: Small—50,000 to 300,000 pounds per day; Medium--
    300,000 to  1,000,000 pounds per day; and Large (super-sized)--over
    1,000,000 pounds per day.  As noted elsewhere, the smallest plants
    are typically the hot cooked and natural breakfast food types of plants,

                               1-9

-------
 According to Census, 25 of the 47 plants have 20 employees or more;
 or,  conversely,  22 plants have less than 20 employees.  Based on this
 data, the "typical" small plant would not employ the average shown.
 More precise data were not available,  however.

 4.   Relationship of Segments to Total Industry
The following summary of Census of Manufactures data for the SIC 204
grain mill products industrial group provides a basis of comparison  for
the industry segments in this study.
SIC    Description

2041   Flour milling

2042   (See 2047 and 2048)

2043   Cereal preparations

2044   Rice milling

2045   Blended flour

2046   Wet corn milling

2047   Pet food

2048   Prepared feeds
          Number of        All        Value  of
        Establishments  Employees   Shipments
                          (1000)       ($ mil.)
               541-'       18.0 -'       2,45lL/
4/
47 y
56 y
us y
41 y
204 y
2,087 y
12.8 -/
4.0 y
6.3 i7
12. i y
13.7 3-/
43.S3-/
i.oss y
679 -'
574 ?-/
832 y
1,359 -/
4,952 y
L/ 1967 Basis
y 1971 Basis
y 1972 Basis
I/ SIC 204 2 split in 1972 into SIC 2047 and 2048 as described.

As portrayed in this summary,  cereal preparations (SIC 2043) is an important
industry segment within the 204 group both  in terms of employment and value
of shipments despite the relatively small number of plants within this industry.
                                1-10

-------
As is later described in detail,  not all portions of the breakfast cereals
industry have major water effluent problems.  However, the summary
shown indicates that this industry is an important economic member
of the  grain mill products industrial group.

5.   Likely Impacted Segments

Within the cereal breakfast food industry, only one class of plants have
substantial water effluent emissions,  i.e. , the RTE  (ready-to-eat) cereal
plants.  The hot cooked and natural cereal types of plants do not generate
significant water effluents.   (Naturally,  combination plants with RTE
cereals would produce  effluents of concern.)

Subsequent RTE model plant cost  analysis of water pollution controls is
used to establish the expected economic impacts on representative plants.
In general,  cereal breakfast food  operations appear quite viable and this
industry segment as a whole is  economically strong.  In other words, the
industry in general may be expected to withstand moderate pollution control
costs without major adverse consequences.

The smaller sized cereal breakfast food plants are the most vulnerable
plants insofar withstanding added  pollution control costs. However, the
small RTE plants,  e.g., 200,000 Ibs/day, are substantially larger than
either the hot cooked or natural breakfast cereal plants.

This size characterisitc of  the  RTE subsegment reduces the differential
impacts among RTE plants,  i.e. , even "small" RTE model plants have
considerable economies of scale in production (and waste treatment costs
per  unit of flow) as is  later shown in Chapter VI.
              B.   Wheat Starch Processing Segment


 The wheat starch processing industry segment includes plants primarily
 engaged in manufacturing wheat starch and vital wheat gluten.  This in-
 dustry is currently experiencing technological shifts in processing.  New
 entrants into the industry utilize improved technology to better supply vital
 gluten products.
                               1-11

-------
1.   Types of Firms


                    Size and Number of Firms
The wheat starch processing industry is  comparatively small; there are
only 6 firms with a total of 7 plants currently in operation.   (However,
two new operations are expected to come on-stream in 1974,  which will
increase gluten capacity in the industry by more than 25 perck^t.  These
new plants have been designed to meet high environmental quality standards
and they will not require added environmental control  modifica&pns as
generally described herein.) A listing of wheat starch industry firms
and plant locations  is shown in Table 1-3.

Major wheat starch processing plants are typically affiliated with large,
diversified corporate operations with wheat starch processing being a
relatively small part of the total corporate business.  Flour milling
operations are generally a main part of the total company business, and
the wheat starch processing plants utilize low grade flours g.nd £,econd-
clears from these mills.  In all existing plant cases, .a wheat search
processor is closely connected with a flour milling operation as a source
of raw materials for processing.


An important aspect of wheat starch processing is that starch, per se,
is only one of two main product streams.  (Wheat starch is a relatively
minor source of industrial starch compared to corn starch wh^ch is
the dominant industrial starch source in  the United States.)   Vital
wheat gluten is  also separated in the wheat starch separation process;
and this product is a high-valued by-product stream.  In .fact, it might
be considered the primary product by some, e.g. , Pills bury. Vital
wheat gluten is  used in cake mixes, specialty breads,  etc. to enhance
baking quality characteristics.
              Level of Integration and Diversification
Wheat starch processing plants are typically affiliated and/or vertically
integrated with much larger grain milling industry firms,  especially
flour milling  companies.  In the wheat starch industry, General Mills
and Pillsbury represent dominant diversified  companies.  Centennial
                                1-12

-------
Table 1-3.   Wheat starch industry firms and plant locations, 1973
   Centennial Mills
   Spokane, Washington
   Plants:   Portland, Oregon
            Spokane,  Washington

   General Mills
   Minneapolis, Minnesota
   Plant:    Keokuk, Iowa

   Midwest Solvent Co.
   Atchison, Kansas
   Plant:    Atchison, Kansas

   New Era Co.
   Arkansas City, Kansas
   Plant:    Arkansas City, Kansas

   A. E. Staley
   Decatur, Illinois
   Plant:    Columbus,  Ohio

   Loma Linda
   Riverside,  California
   Plant:     Riverside,  Cal.
                                              Estimated Capacity
                                                    Cwt/day
    1,000
    1,000
    1,000
      100
      750
    1,500
       NA
   New Plants to be Operating in 1974 ;_
   Pillsbury
   Minneapolis, Minnesota
   Plant:     Minneapolis,  Minn.

   Far- Mar-Co.
   Hutchinson, Kansas
   Plant:     Hutchinson, Kansas
    2,000
Pilot Plant
                          1-13

-------
Mills and Far-Mar-Co are leading milling companies; and A. E. Staley
Manufacturing is a leading corn wet milling company.

Wheat starch processors or  their parent companies are not generally
integrated to the wheat grower level,  however.  Rather, the grain
milling companies  generally acquire grains for processing in corn-
modi cies markets.  Some exceptions may arise in the case of new
hydro-processing plants, e.g., Pillsbury, which will utilize whole
grain wheat with high protein content.  A potential exists for grower
contracts to  supply the desired varieties of wheat for processing.

Wheat starch and gluten products are intermediate products which
are used in further manufacturing processes. U.  S. production of
these products serves only domestic markets directly, although the
parent organizations or users of these input products may  be involved
in international production and marketing.  The U.S.  is a  net importer
of wheat starch and gluten products.

2^   Types of Plants

The  sizes and locations of wheat starch plants were presented in Table
1-3 above.  These plants are generally located in wheat producing areas
and essentially all plants are near (adjacent to) flour mills.  Low grades
of flour and second-clears from  the flour mills are the primary raw
materials used in wheat starch operations.

Most existing wheat starch plants (excluding the two new plants  scheduled
for production in 1974) are relatively old plants.  Wheat starch processing
technology has remained basically unchanged until recently.  In its new
plant, Pillsbury will introduce major technological changes--generally
referred to as hydro processing  or wet processing of wheat.  In this case,
whole wheat  is processed and vital wheat  gluten is the  primary product
(rather than  wheat starch).   Far-Mar-Co is also introducing major
technological changes  in its' pilot plant operation, much of which is
believed similar to the Pillsbury wet processing method.  Henc~  the
new  operations should be regarded as new types of plants in tht '   astry.

Neither investment nor operating cost and revenue data concerning the
new  plants are available. Such cost data are proprietary,  and operating
data are not  yet known.  Pillsbury has described its new operation as a
multi-million dollar facility, and the capacity is estimated at about-twice
the typical wheat starch processing plant  capacity of 1,000 cwt/day.
                                1-14

-------
3.  Number of Plants and Employment

As shown in Table 1-3, the wheat starch processing industry is currently
comprised of seven plants with two new facilities expected to come on
stream in 1974.  Employment data were estimated as described next.

This industry is a relatively minor segment of SIC 2046--Corn Wet
Milling; and reported Census of Manufactures data cannot be accurately
partitioned to apply to this segment only.  Hence, estimates of employ-
ment were made  for a representative model plant, i.e. ,  1,000 cwt.
per day, based on engineering synthesis of manpower requirements.
By this procedure it was  estimated that a representative plant requires
about 20 employees.  Fifteen (15) or 75 percent are estimated as
production workers; and the  remainder would represent general ad-
ministrative, office and sales personnel.

Total employment in the wheat starch processing industry would equal
about 140 to 150 using the estimated average of 20 employees per  plant
multiplied by 7 existing plants.   This estimate excludes the two new
plants scheduled  for operation in 1974.  These plants would increase
employment to about 200  (estimate only).

4.   Relationship of Segment to  Total Industry

Wheat starch processing  is classified by Census of Manufactures as
a sub-segment of the corn wet milling industry (SIC 2046) and regarded
as a relatively minor economic sub-segment of this SIC group (see
Section A-4 above).  Further, wheat starch processing industry statistics
are embedded within SIC  2046, wherein corn wet milling operations
eclipse wheat starch operations  in employment, and in value of ship-
ments .                          ,

That is well over 95 percent of  the employment and value of shipments
indicated is attributable to corn wet milling operations (which were
previously studied by EPA).  The seven wheat starch plants represent
a total employment of only about 150 employees  and value of shipments
in the order of $17 million.

While wheat starch operations appear relatively minor by comparison,
their principal products (wheat  starch, and  especially vital wheat  gluten)
have important industrial and food processing (especially baking) appli-
cations.  Furthermore, recent technological breakthroughs (e.g.  hydro
processing) hold  promise for potentially major growth by this industry.
                               1-15

-------
In summary, while this industry is relatively small, it is important
to overall food processing operations, and growth in the  industry is
expected.

5_.   Likely Impacted Segments

Wheat starch processing operations would be severely impacted  pursuant
to the  establishment of the  proposed effluent limitation guidelines if
private treatment systems  are required.  This is expected based strict]-/
on the large volume-low value of end products nature of  the industry.
While  vital wheat gluten i?  relatively more valuable than wheat starch,
this component is but a small fraction, e.g.,  14 percent of the pro-
cessed input.  Also, wheat starch is a generally minor industrial source
of starch in the U.S.  Hence,  this industry will have difficulty competing
with other starch industries,  e. g. ,  corn starch,  if pollution controls
are  relatively  costly.

Differential pollution control costs among plant sizes may be significant
in the  wheat  starch processing industry,  but, most existing plants  discharge
into municipal systems.  This will mitigate direct impacts of the controls
proposed in this  study.  Also, it is unlikely that a small-scale new plant
v/ould  be constructed using prevalent technology.
                                1-16

-------
                    II.  FINANCIAL PROFILES
Financial data  relating to individual operating plants, i.e. , either cereal
breakfast food  or wheat starch processing, are not available.  Data which
are available are published financial data for the large, publically held
companies. Since many of the companies involved are generally widely
diversified corporations, the data  cannot be used to specifically reflect
the cereal (or wheat starch) divisions nor the  industry segments as  de-
fined in this study.  However, such data, as summarized below,  does
reflect the general economic viability of firms involved in these industries.

Given the limitation of having only general financial data about major
companies, model plant budgets are proposed as the best means  of
achieving reasonable insight into the financial aspects of various repre-
sentative operations.  Model plant configurations,  matched to sizes and
product mix characteristics within these industries have been established
as indicated in Table II-1.
                A.   Cereal Breakfast Food Segment
 1.   Plants by Segment

 Within this section the primary areas of interest include industry profit-
 ability, capital structure, cost of capital, pro forma income statements
 for model plants, invested capital for model plants and the cost structure
 of model plants by segment.  Much of the information requested by EPA
 was not generally available for these industry segments,  and considerable
 reliance was placed on the model plant configurations and estimates as
 s hown.
                       Industry Profitability
A  general indication of the financial characteristics of the cereal break-
fast food  industry under study is suggested in Table II-2.  These  selected
financial  measures, i.e. , net pr;ofit as a percent of sales,  net profit as a
percent of net worth, and current ratios, provide a general perspective
on operating characteristics within this industry segment.
                               II-1

-------
         Table II-1.  Model plant configurations by segment
                                            Annual
                                            operating           Annual
Segment	Capacity	days —'        production
                         (1,000 Ibs/day)         "     """(1,000 Ibs)

Cereal Breakfast Food
    Small                       200          234               46,800
    Medium                     500          240              117,000
    Large                     1,200          240              280,800

Wheat starch processing     (1,000 cwt/day)
    Medium                  1,000           250             250,000
_' Estimated annual equivalent days of capacity operation, calculated As 260
   times 90 percent utilization for cereal breakfast foods. Wh«at starch
   processing operating days based on average days reported in the flour
   milling industry.
                               II-2

-------
 Table  II-2. Selected financial data for breakfast cereal companies.
Companies

Kellogg
General Mills
General Foods
Quaker Oats
Ralston Purina
IntM. Multifoods
Nabisco

Kellogg
General Mills
General Foods
Quaker Oats
Ralston Purina
Int'l. Multifoods
Nabisco
1972

8.7
3.4
2.7
4.4
3.4
1.9
4.5

21.3
12.4
8.4
13.4
13.8
8.7
16.0
1971
Net Profit
8.2
3.9
8.2
3.6
3.2
1.7
4.7
Net Profit
20.8
13.2
23.6
10.5
NA
8.4
15.6
1970
as a Percent
8.1
2.7
4.9
4.7
3.6
1.7
4.6
as a Percent
20.3
NA
NA
NA
NA
NA
NA
1968
of Sales
8.9
4.4
5.8
3.9
2.9
1.5
5.4
1963

8.8
NA
NA
NA
2.7
1.6
NA
of Net Worth
20.3
NA
NA
NA
NA
NA
NA
22.6
NA
NA
NA
NA
NA
NA
                  Current Ratio  (Current Assets to Current Liabilities)
Kellogg
General Mills
General Foods
Quaker Oats
Ralston Purina
Int'l. Multifoods
Nabisco
2.2-1
1.7-1
1.9-1
2.2-1
2. 1-1
2.0-1
2.0-1
2.0-1
1.7-1
2.0-1
2.3-1
2.2-1
1.7-1
2.3-1
2.0-1
1.9-1
2.0-1
2.0-1
1.9-1
1.7-1
2. 1-1
2.3-1
2. 1-1
2.0-1
2.3-1
2. 1-1
2.0-1
2.3-1
2.0-1
2.7-1
2.2-1
NA
2.2-1
2.3-1
2.3-1
Source: Standard & Poors Stock Reports
        Securities and Exchange Commission,  10K Reports
                                II-3

-------
Attention is subsequently focused on financial characteristics of model
plants which have been developed for this  study.  Model plant data does
not correspond to any one operation, but such data are  generally consiS'
tent with financial data which is available  from both published sources
and DPRA  files.   The latter includes contacts with industry sources.

For example, as shown in Table II-3 below,  net income after taxes
range from about 8 to 11  percent as a percent of sales for three model
cereal plants.  These estimates  and their derivation are discussed
further below.
                         Capital Structure
Capital structure ratios are similarly difficult to estimate for the RTE
industry segment involved.  However, the major cereal companies have
recently had a fixed debt to net worth ratios averaging about . 2 to .6.
Total liabilities to net worth ratios averaged about . 4 - 1.2 in the
1970-73 period.  Also, the current ratios (current assets to current
liabilities--see  Table II-2) have averaged about  2.0, ranging from
about 1.7 to 2.3 for more  than five years.
                           Cost of Capital

An estimated cost of financing new investment has been derived from
an analysis  of the financial reports of the  publicly held companies.  This
method has  an obvious shortcoming:  the companies for the most part
are widely diversified corporations whose earnings and capital structure
reflect multi-product operations.   In spite of this weakness,  there are
no better available data for estimating cost of capital.

The method used to estimate the cost  of capital involved a computation
of debt and equity ratios to total invested capital and the calculation of
five-year averages for dividend yield  and  earnings on common stock.
The estimated averages were as follows:
                                       Cereal Industry
                                           Ratios
       Common equity/Invested capital     .650
       Long-term debt/Invested capital     .350
       Dividend yield,  5-year average      .034
       Earnings on common stock,          .059
          5-year average

                            II-4

-------
In estimating the cost of capital, other assumptions were made:  long-
term interest rates average 10.0 percent, the corporate tax rate is
48 percent and the growth rate in dividends will be at least equal to
the annual inflation rate,  which is estimated at 5 to 6 percent.

The cost of equities was estimated by the dividend yield method.  This
is a simplification of the  more complex DCF methodology.  The dividend
method is:
      where
k  =  p
                                     g
                         k  =  cost of capital
                         D  =  dividend yield
                         P  =  stock price
                         g  =  growth

 The after tax cost of debt capital was estimated from reported (annual
 financial reports and financial statistics) company outlays for interest
 expenses and multiplying by . 52 -- assuming a 48 percent tax rate.
 These values were weighted by the respective equity to total asset and
 total liabilities i' to total asset ratios.

 The average cost of capital for the cereal breakfast foods industry was
 estimated using the equity and debt data reported  earlier as follows:
Dividend Yield plus Growth

  Cereal Breakfast Foods
    Equity
    Debt (10.0 x 52%)
    Ave. Cost of Capital
                                      Weight    Cost    Growth   Wt'd cost
.65
.35
.034
.052
                                .05-. 06
                                                                  .072-. 082
                                                                  .018
                                                                  .09-. 10
 Based on this procedure, the estimated cost of capital is from 9.0 to 10.0
 percent for the cereal breakfast foods industry segment.
 i'  It is recognized that liabilities contain non-interest bearing liabilities,
    but its weight is believed to be an adequate proxy for the weight of debt.
                              II-5

-------
          Pro Forma Income Statements - Model Plants


  Pro forma income statements and financial returns for selected model
  plants are shown in Tables II-3 for the cereal breakfast food segment.
  The model plant configurations shown are generally representative of
  operating plants within this industry segment as was described in
  Section I-A above.

 A word of caution is that model plant estimates are based upon best avail-
 able information concerning industry practices and procedures.  Standard
 financial ratios and cost-synthesis procedures were necessary in cases
 where  no better information was available.   As such, model plant estimates
 are useful  guides, but such data should not be used literally for a given
 operating plant.
In a general overview, as shown in Table II-3,  cereal breakfast food plants
are capital intensive in absolute terms, but invested capital to annual sales
ratios are relatively low compared to other manufacturing industries.  This
factor is especially pertinent in understanding this industry segment  rela-
tive to other food processing industries.

Direct processing expenses, including raw materials (oats, wheat, corn,
etc.) are particularly low relative to sales, i.e. , approximately 47 to 51
percent as shown in Table II-3.  In contrast indirect expenses are relative-
ly high (about 2Q percent) which is largely attributable to the marketing and
sales  cost component.   A commonly reported figure  in the cereal breakfast
food industry is that 13 percent of sales is  allocated  to advertising and
promotion, which is probably representative of various packaged foods
industries, but high relative to other food and kindred products industries.


 Annual Profits After Taxes.  The medium (500,000 Ibs/day) model plant
shows a net income of about $6.2 million on sales of $58.5 million, or
 10. 5  percent on sales.  The small and large model plants have  compa -*b\e
 net income to sales percentages of about 8.0 percent and 11.0 percent,
 respectively.  Relatively minor scale economies are suggested in this
 analysis.

Another general indication of profitability  is net income after tax as a
 percent of invested capital which ranges from about 16 to 20 percent for
 the three cereal breakfast food model plants as shown in  Table  II-3.
 This  rate of after-tax return is regarded as relatively high compared
to the average for all industrial firms.

                                II-6

-------
            Table II-3.  Pro forma income statements and financial returns for
                           selected model cereal plants by size
Small
200,000 Ibs/day

Invested capital —
Annual sales
Direct expenses
Raw materials
Labor
Packaging
Freight
Other manufacturing expenses
Subtotal
Indirect expenses
Warehousing
Marketing and sales
General and administration
Subtotal
Total operating expenses
Depreciation
Interest (long-term)
TOTAL COSTS
Net income before tax
Net income after tax
Cash flow
Net income before tax as a
percent of invested capital
Net income after tax as a
percent of invested capital
$000
15,470
23,400
5,101
725
2,621
1,942
1,427
11,816
585
4,516
2,036
7,137
18,953
700
164
19,817
3,583
1,863
2,563

--

- -
(%)

100.0
21.8
3.1
11.2
8.3
6.1
50.5
2.5
19.3
8.7
30.5
81.0
3.0
.7
84.7
15.3
8.0
11.0

23.2

12.0
Medium
500,000 Ibs/day
$000
33,500
58,500
11,993
1,521
6,201
4,739
3,276
27,730
1,346
10,998
4,622
16,966
44,696
1,596
351
46,643
11,857
6,166
7,762

--

--
(%)

100.0
20.5
2.6
10.6
8.1
5.6
47.4
2.3
18.8
7.9
29.0
76.4
2.7
.6
79.7
20.3
10.5
13.3

35.4

18.4
Large
1,200,000 Ibs/day
$000
75,500
140,400
28,782
3,510
14,461
11,232
8,003
65,988
3,510
26,956 '
9,828
40,294
106,282
3,698
702
110,682
29,718
15,453
19,151

--

--
(%)

100.0
20.5
2.5
10.3
8.0
5.7
47.0
2.5
19.2
7.0
28.7
75.7
2.6
.5
78.8
21.2
11.0
13.6

39.4

20.5
I/
   Includes working capital
                                            II-7

-------
Annual Cash Flow.  Annual cash flows (after-tax income plus depreci-
ation) for the cereal breakfast foods industry are moderately hiqh in
relation to sales (11 to 13 percent) based on the model plant analysis
(Table II-3).   Depreciation allowances as a percent of invested capital
range from 4. 5 to 4. 9 percent for the cereal model plants.  These
percentage estimates are  nominal in relation to all manufacturing
industries but due to the capital intensiveness of the industry, depreci-
ation allowances add substantially to the cash flow position.  Cereal
plants  generally have relatively long production life-expectancy,
although recurrent modernization improvements are made.
                 Invested Capital - Model Plants
Investment has been estimated for each of the model plants utilizing two
primary methods:  replacement value method,  and book value method.
Data availability constraints most affected the primary method used,  but
both replacement values (1972) and book values  (1972) are estimated for
all cereal model plants as shown  in Table II-4.  Furthermore,  estimated
salvage values are also presented; and these estimates are subsequently
used in plant closure analyses.

Financial data including book values  of invested capital, for the major
cereal breakfast foods companies (which are publically held) are contained
in published Securities and Exchange Commission's 10K Reports.  Also,
stock reports, such as published  by Standard and Poors, are available.
These data  reflect principal economic relationships for these companies
as a whole.

Although neither individual plant  data nor unique product data may be
determined from the above sources, it is generally possible to construct
model plant information which reflects basic underlying economic factors.
Further,  in some cases, domestic and international operations are separated;
and, also, some division data (principally cereal operations, for example)
may be reported.

From  such  information, book value estimates of invested capital, including
working capital, depreciation, interest and other cost interrelationships
were derived for this study.  As  previously  stated, such data should Only
be used as a guide insofar as a  specific plant is concerned; and careful
use of the data should be made with reference to any single operation.
                               II-8

-------
           Table II-4.  Estimated replacement, book and salvage values for model

                                         plants by segment




           c      <.   j %, j  i •»•  *.           Replacement    Book   Salvage
           Segment and Model Plant               ,_ .         „ .      ,,  *
                                                 Value •	Value    Value

                                                ($000)        ($000)    ($000)



           Cereal Breakfast Food —



                  200,000 Ibs/day             $21,145     $15,470   $8,390



                  500,000 Ibs/day                46,450      33,500    17,340



                 1,200,000 Ibs/day               105.525      75,500    38,010
           I/
           - Base data available for cereal plants were book value estimates.  Other

             values derived from these values as explained in text.
i
                                        II-9

-------
Reported book values of established firms generally understates the current
replacement value for similar facilities,  e.g., due to accumulated deprecia-
tion of assets and higher current costs of construction.  Thus, one should
not assume  that a relatively new plant,  or a proposed new plant, would
necessarily achieve  the same rates  of return to capital as have, been shown
in Table II-3 (which  are based on book value estimates of. invested capital,
etc. ).   Using replacement investment costs as shown rather than book
values, the  return to capital would be reduced by about 5 percent as is
later discussed in Chapter VI.

Replacement values  (and salvage values) as also shown in Table  II-5,  were
estimated, in this case, using book values as a starting point.  The follow-
ing assumptions and procedures were involved:

                              % of      Estimated Percentage  Relationships
                              Total     Replace.      Book      Salvage
 Capital Cost_Itern_            ££;!l_     Value        Value       Value

 Land                           3%        100%        100%        100%
 Buildings                      32          150          100           ID-
 Equipment                     65          175          100           20
 Working Capital                —        100          100          100
In general,  land and working capital components are assumed equal in terms
of replacement, book and salvage values.  Land values were  subjectively
valued on a replacement cost basis and held constant.  Reported book values
vary markedly among companies and not precise plant data only was avail-
able.   Buildings and equipment, however,  have estimated replacement costs
greater than book values; and estimated salvage values are much lower than
book values.

For the three model cereal breakfast foods plants, the following book   .ues
were estimated:

                                                 Model Plant
      Capital Cost Item               Small       Medium
                                           	($1,000)
      Land                        $    270       $    600       $  1.400
      Buildings                       2,800         6,400        14,900
      Equipment                     5,700        13,000        30,100
      Working Capital                6.700        13.500        29, 100
      Total Invested Capital         15,470        33,500        75,500

                               11-10

-------
Based on these estimated book values and the above replacement value
and salvage value assumptions relative to book value,  the estimates in
Table II-5 were derived.
                   Cost Structure - Model Plants
The cost structure of the model plants, as depicted in Tables II-3 above
is reflected in part by comparing line items as a percent of sales.  For
example,  direct raw materials costs for cereal plants have been estim-
ated at about 20 to 22 percent of sales.  Compared to other food and kindred
products processing  industries, these  cereal plant ratios are low.  Usually
raw materials costs  represent  a much higher proportion of total sales in
food processing industries.

Indirect expenses, including warehousing,  marketing (selling) and general
and administrative expenses are relatively high in the breakfast cereal
industry.   Packaged  foods, such as breakfast cereals, have traditionally
been very consumer-marketing oriented including extensive use of public
promotional programs.  Hence, the low relative cost of raw materials
can be attributed partially to the high marketing-distribution cost factors
as indicated.

2.   Distribution of Data
A summary of after-tax income, return of invested capital, return on sales
and estimated annual cash flows for the cereal model plants is presented
in Table II-5.  These estimates  reflect relatively minor production eco-
nomies of scale, in general, in the cereal breakfast foods industry seg-
ment.   The larger  operations tend to have higher profit rates as a percent
of invested capital,  but this is less pronounced as a percent of sales.
Overall, all sizes of model plants  shown appear exceptionally viable  in
the economic factors indicated.  The proportion of costs shown for mar-
keting and distribution are essentially  constant among the model plants
based on available  data.  There are perhaps greater economies of scale,
in marketing-distribution vs. production, but this relationship cannot
be demonstrated with known data.

External as well as internal economic  factors also condition a firm's
ability to finance new investment.  The general outlook for the economy
and industry-wide prospects (independent of an individual firm)  relative
to the total economy will affect capital investment financing for  all firms
within an industry.
                               11-11

-------
Table II-5.  Summary of after-tax net income, return on invested capital,
            return on sales and cash flows of model plants by segment.
Segment and
Model Plant
                                     Net Income (After-taxjarofit)
 Total
As a % ,of
 Invested
 Capital
As a % of
  Sales
Cash
Flows
Cereal Breakfast Foods

       200,000 Ibs/day

       500,000 Ibs/day

     1,200,000 Ibs/day
($000)



 1,863

 6,166

15,453
  12.0

  18.4

  20.5
                                                               ($000)
    8.0      2,563

   10.5      7,762

   11.0     19,151
                                11-12

-------
 The general economic outlook for the next few years has been clouded
 over by uncertainties surrounding economic policies and critical short-
 ages of many basic resources. The lack of certainty in policies has been
 intensified by political instabilities.  In one direction the U.S.  economy
 faces the possibility  of direct wage and'price controls, with or without
 rationing, but with virtually certain accompaniment of shortages of
 critical materials.  Under these conditions, rates of economic growth,
 inflation and capital spending are subject only to speculative thinking.
 On the other side, the economy may undergo adjustments to present
 conditions,  relying largely on market pressures to cope with scarcities,
 inflation and problems of growth.

 3.   Ability to Finance New Investment


 The ability of a firm to finance new investment  for pollution abatement
 is a function of several critical financial and economic factors.  In
 general terms, new capital must come from one or more of the following
 sources:  (1) funds borrowed from outside  sources; (2) new equity capital
 through the sale of new common or preferred  stock; (3) internally gener-
 ated funds -- retained earnings and the stream  of funds attributed to de-
 preciation of fixed assets.

 FOP each of the three major sources of new investment,  the most critical
 set of factors is the financial condition of the individual firm.  For debt
 financing, the firm's credit rating, earnings record  over a period of
 years,  stability of earnings,  existing debt-equity ratio and the lenders'
 confidence in management will be major considerations.  New equity funds
 through the sale of securities will depend upon the firm's future earnings
 as anticipated by investors, which in part reflect past earnings records.
 The firm's  record, compared to others in its  own industry and to firms in
 other similar industries, will be a major determinant of the ease with which
 new equity capital can be acquired.  In the  comparisons, the investor will
 probably  look at the trend of  earnings for the past five or so years as  well
 as the future environment the firm faces.   Internally  generated funds
 depend upon the margin of profitability and the cash flow from operations.
 Also, in publicly held corporations, stockholders must be willing  to fore-
 go dividends in  order to make earnings available for reinvestment.

Heavy demands  for capital funds  have been  expected by both public and
 private organizations to compensate for resource and product shortages.
 Federal,  state and local regulatory actions have added to capital and re-
 source  demands.  These  factors will keep upward  pressures on money
                               11-13

-------
rates.  In addition, inflation will push interest rates higher as lenders
demand a larger inflation premium.  The next few years, capital funds
are likely to be available,  but at rates approaching the historic high
levels of 1969-70 when long-term,  high grade corporate bonds yielded
9 to 10 percent.  The cost of financing new investment will be high com-
pared to the 1950's and early 1960's.

Section II-A-1 contains a discussion of the  profitability,  capital structure
and cost of capital for the  cereal segment under consideration.  In sum-
mary, the cereal breakfast food industry has recorded generally high
rates  of profit and the large-diversified corporate structure suggests
a strong capability for financing new investments.  Both internal funds
and external sources of capital  are believed generally available to this
industry segment.  Also, the prospects  for industry growth relative
to the total economy are good.  Cereal food demands  have generally in-
creased despite higher costs of production  and higher prices to con-
sumers.  Cereal products have partially replaced even higher cost food-
stuffs which cannot be supplied  as readily or  as economically as cereal
based products within the food industry as a whole.

Another important financial consideration in the breakfast cereal in-
dustry involves market share relationships as were described above.
Existing firms with established market shares could more likely obtain
financing from external sources.  Marketing  and sales costs within the
cereal industry are exceptionally high relative to all manufacturing
industries.  A new plant might readily develop production capability,
but market penetration would probably be difficult.
              B.   Wheat Starch Processing Segment
The financial characteristics of the wheat starch processing segment are
discussed in this section.  The reporting format is the same as that used
in Section II-A above for the cereal breakfast food segment.  Many of the
procedures  used for developing the financial data are the same as those
previously described, and unless otherwise stated, the procedures use '
in the cereal industry are  applicable here.

Financial data  for wheat starch processing operations are  extremely diffi-
cult to estimate.  Reported company data apply to total corporate oper-
ations  of which wheat  starch processing is usually a minor part.  In most
cases, wheat starch plants utilize low grade flours from affiliated milling
operations. For this  reason it might be  said that the financial capability
                               11-14

-------
of a plant to install pollution control facilities is  linked to the overall
financial condition of the parent company.  However, not all plants
are financially tied to other grain milling operations, and attention
will be given to a wheat starch plant as an independent unit.'

To accomplish the objectives of this study, model plant financial char-
acteristics have been developed using engineering and economic cost
synthesis methods.  Model plant data were estimated following plant
visits and other contacts with industry sources.  Limited data were
available  from secondary data sources.

1.  Plants by Segment

The wheat starch processing industry consists of one segment only as
depicted in this analysis.  Regardless  of their financial linkage to other
grain mill products operations, existing wheat starch plants, per se,
are similar in their production processes.  The two new  plants under
construction should be  treated as a second segment because of tech-
nological changes. However, operating data are not yet available for
the new plants.  The  proposed effluent guidelines are expected to apply
to the new plants, but the waste flow characteristics and  associated
treatment requirements may differ. (The new Pillsbury  plant has been
designed with regard to meeting high environmental control standards;
the Far-Mar-Co pilot plant will discharge into a  municipal  waste treat-
ment  system during the trial operating period. No definite waste treat-
ment  plans have been announced by Far-Mar-Co  for full-scale pro-
duction. )
                       Industry Profitability
Historically, the grain mill products industry in general has had aver-
age net profit to sales ratios  of about 1.8 to 3.6 percent and net profit
to net worth  ratios of about 8.0 to 11.9 percent.  These ratios are
generally below averages reported for all manufacturing industries.

Based on model plant analysis, the wheat starch processing segment is
estimated to have about a 3.9 percent net profit to sales ratio as shown
in Table II-6.  Although this  ratio is higher than the above range,  it is
comparable.   This estimate and its derivation are discussed further below.
                               11-15

-------
                         Capital Structure
Wheat starch processing operations cannot be financially segmented
from available sources, but as a broad indication, the flour milling
industry in general might be considered comparable.  In this case,.
fixed debt to net worth ratios have ranged from about . 2 to .4, and
total liabilities to net worth have been from about .6 to 1.0 since the
late 1960's.  Also,  current ratios have ranged from about 1.8 to 2.2
since 1968 on the average.

These general indicators suggest that grain milling firms would have
moderate financial  strength and capacity to expand operations without
serious detriment to underlying financial ratios.  Such average in-
dicators should be used with caution, however. Individual plants may
differ significantly  from such averages.
                          Cost of Capital
The cost of financing new investment has been estimated based on analysis
of financial reports of pub lie ally held companies in the grain milling i»>-
dustry.  Such data generally represent diversified corporations whose
earnings and capital structure reflect multi-product  operations, but no
better data were available.

Estimates of debt and equity ratios to total invested capital and averag*
dividend yields and earnings in the grain milling industry were as follows:

                                                 Milling Industry
                                                     Ratios

       Common equity/Invested capital               .670
       Long-term debt/In vested capital               .330
       Dividend yield,  5-year average                .031
       Earnings on common stock,  5-year
                 average                             .072

As previously noted,  other assumptions must be made to estimate an
average  cost of capital,  namely:  long-term interest rates were estim-
ated at 10.0 percent, the corporate tax rate was 48 percent,  and the
growth rate in dividends was  estimated at 5 to 6 percent.


                                H-16

-------
Also, the dividend yield method for estimating the cost of equity capital
was used.  That is,  the following procedure was used:
              *  .   !  *  .
                     ^                      1,1,
       where k  =
              D  =
              P  =
              g  =
cost of capital (equity portion)
dividend yield
stock price (average)
growth rate
Using the above methods and financial data estimates,  the average cost
of capital for the wheat starch processing industry was derived as follows:
Dividend Yield plus Growth

  .   Wheat Starch Processing
       Equity
       Debt (10.0% x 52%)
         Ave. Cost of Capital
              Weight     Cost    Growth
                .67
                .33
.031
.052
.05-.06
.071-.081
     .017
.088-.098
As indicated,  the composite average cost of capital is estimated as ranging
from .088 to .098 for the wheat starch processing industry segment.  In sub-
sequent analyses,  a .09 percent rate is used as a target estimate.
            Pro Forma Income Statements - Model Plant
Pro forma income statements and estimated financial returns for the wheat
starch processing model plant are as  shown in Table II-6.  These data re-
flect a moderate level of invested capital for a "typical" plant.  In this
case, direct operating expenses are by far the dominant (86 percent of
sales) cost category; and raw materials (clears and low-grade wheat
flour--plus whole wheat in new plants) account for most of this direct
operating cost.  Indirect expenses are generally low--representing only
4 to 5 percent of sales based on data available.

Annual Profits After Taxes.  The model plant analysis for wheat starch
processing resulted in an estimated 3.9 percent net income (after taxes)
to sales relationship. This percentage is comparable to the average re-
turn on sales for most grain mill products industries.   Also,  net income
after tax as a percent of invested capital was approximately 13 percent
as shown in Table II-6.  These ratios  reflect moderate  rates of return
in relation to all manufacturing industries.
                               11-17

-------
Table II-6.  Pro forma income  statement and financial return for a
                      selected model wheat starch plant.
                                           Capacity
                                        1, 000 Cwt. /day
                   Percent
                   of sales
                I/
Invested capital —

Annual sales

Direct
  Raw materials
  Labor
  Heat and power
      Subtotal

Indirect expenses

Total operating expenses

Depreciation

Interest  (long-term)

TOTAL COSTS

Net income  before tax
Net income  after tax

Cash flow

Net income  before tax
  as a percent of invested capital

Net income  after tax
  as a percent of invested capital
(,$000)
  770

2,590
2, 100
   115
	5
2,220

   112

2, 332

    36

	27

2,395

   195
   101

   130
 2.9.7

LO.0.0


 81. 1
  4.4
   .2
 8S,. 7

  4.3

 90.0

  1.4

  1.0

 92.5

  7.5
  3.9

  5.0


 25.3


 13.  :
— Includes working capital.
                                 11-18

-------
Annual Cash Flow.  The wheat starch plant cash flow as a percent of
sales is estimated at about 5 percent as shown in Table II-6.  Depreci-
ation allowances,  which contribute to cash flow, account for about 1.4
percent of the 5 percent estimate.  Depreciation allowances also repre-
sent 4.2 percent of the overall invested capital,  which is nominal for
most manufacturing industries.  No attempt was made to determine
optimum depreciation methods for tax purposes,  rather a straight-line
depreciation schedule was used.
                  Invested Capital - Model Plant
Investment requirements for a prevalent technology wheat starch plant
were estimated using the replacement value method (1972 basis).  Eng-
ineering cost synthesis techniques were used to establish land,  site
preparation,  building and equipment investment costs.  Further, book
value and salvage value  estimates were estimated from the "replacement
value" derived by taking into account the probable age and condition of
existing plants in the industry.  These estimates  are  shown in Table II-7.

The invested capital replacement cost estimates for a 1,000  cwt/day
model plant were as follows:

                                            Model Plant:
           Capital Cost Item                1, OOP cwt/day
                                              ($1,000)

           Land
           Buildings (Incl. storage)
           Equipment
           Working Capital
           Total Invested Capital
The estimated book and salvage values reported in Table II-7 reflect
the same relative relationships to replacement costs (by category) as
was reported  above for the cereal plants.  Both wheat  starch and cereal
plants have been established for a long period,  and, also, each industry
requires recurrent replacement and modernization of worn equipment.
Further,  it is noted again that the book value estimate was used in cal-
culating model plant returns on invested capital as shown.  Replace-
ment and salvage values were used in later analyses in Chapter VI .
                               11-19

-------
Table II- 7.  Estimated replacement, book and salvage values for the
                     wheat starch model plant
Segment and Model Plant
Replacement     Book   Salvage
    Value        Value     Value
 Wheat Starch Processing —

        1, 000 cwt/day
                                       ($000)
  1, 040
                 ($000)    ($000)
770
520
— Base data for the representative wheat starch processing plant were
   developed via engineering cost- synthesis of a model plant involving
   replacement values.  Hence,  other values derived from this estimate^
   (1972 costs) as explained in text.
                                 11-20

-------
                   Cost Structure -Model Plant
The cost structure of the model wheat starch plant is reflected in
Table II-6 above by analyzing cost items as a percent of sales. Only
one model plant is  shown, so comparisons among plants are not possible.
However, the wheat starch model plant  reflects an exceptionally high
raw materials cost as a percent  of sales, i.e.  about 80 percent.

In contrast, the indirect expenses of the plant,  including marketing
and sales costs  are quite low. Wheat starch and gluten products are
intermediate goods which are inputs into other  manufacturing pro-
cesses.  There  are no  public-oriented promotional programs.and pro-
ducts are generally sold on a private treaty basis.

2.  Distribution of Data                ,

A summary of other financial characteristics,  including after-tax in-
come, return on invested capital, return on sales, and estimated annual
cash flow for the model plant are as shown in Table II-8.  These data re-
flect moderate returns bothcn sales and in relation to invested capital
for the wheat starch processing  segment.  Differences among  plants
are not known, but the  model plant is  believed  representative of this
industry segment as a whole.

3.  Ability to Finance  New Investment

A general discussion of factors affecting the firm's ability to finance
new investment was presented in section II-A-3 above.  Industry-wide
and general economic outlooks as well as an individual firm's  economic
prospects affect capital fund availability and money rates.

In broad terms, the wneat starch processing industry has not been  re-
garded as an  exceptionally profitable industry segment.   The main
strength of the industry is its ties to large flour and other grain mill
products firms, e.g.,  General Mills, Pillsbury,  Centennial Mills,
A. E. Staley, etc.  Thus, via the larger parent organizations, wheat
starch plants may  generally be able to finance  new investments of a
moderate magnitude.  Much would depend on the outlook for principal
wheat starch  processing  products,  especially vital wheat gluten.  That
is, new investments would hinge on productive  output expectations in
relation to investment.
                                11-21

-------
Table II- 8.  Summary of after-tax net income, return on invested capital,
            return on sales and cash flows of model plants by segment.
                                      Net Income (After-tax profit)
                                        As a % of
Segment and                            Invested    As a % of    Cash
Model Plant	Total	Capital	Sales      Flows
                             ($000)         (%)         (%)      ($000)


  Wheat Starca Processing

        l,000cv*t/day         101        13.1        3.9       137
                                11-22

-------
Technological developments in progress, i.e., wet processing of whole
wheat, might limit capital availability for the installation of additional
prevalent technology in the wheat starch processing industry.  As is
later discussed,  anticipated waste water treatment requirements are
a probable deterrent to entry for any plant which may be required to
install its own treatment system.
                                11-23

-------
                           III.   PRICING
                     A.  Price Determination
Markets and pricing of products in the cereal breakfast foods and the
wheat starch processing industries are quite distinct.  Hence, each will
be discussed separately.

Packaged cereal breakfast foods are geared for delivery and sale primarily
to retail consumer markets.  Consequently,  these goods are prepared and
packed for such markets at the processing plant, regardless of whether
intermediate wholesalers, jobbers or other distributors become  involved
in the marketing-distribution chain.  Any marketing-promotion programs
geared to a particular product line are also normally coordinated from the
processor level.

On the other hand, wheat starch processing products (wheat starch and
vital wheat gluten,principally) are produced as intermediate  raw materials
which require further processing. Most "customers" are industrial buyers
such as wheat starch sales to  the paper industry and gluten sales t~> the
baking industry.  In  general, little or no promotional efforts are involved
and primary products within the industry are generally undifferentiable
among processors.

1.  Cereal Breakfast Food Segment

The total value of cereal breakfast foods shipped by all producers was
$925 million in 1972. Industry sales,  including other products, were
over $1 billion.  Ready-to-eat cereals are the principal products prepared,
and based on 1972 Census of Manufactures data, the following approximate
volumes and values of product were shipped:

                                         Estimated       Estimated
      Type of Cereal                       Quantity         Value
                                         (mil. Ibs.)       ($ mil. )
      Ready-to-Eat
        .  Corn flakes  & other              518.2           235.5
        .  Wheat flakes & other             479.7           206.6
        .  Oat breakfast foods              494. 0 U         168. 0 I/
        .  Rice breakfst foods              212.4           141.3
        .  Other, including baby cereals     226.5           113.0
              Subtotal                     1,930.8           864.4
-  Estimate by DPRA.
                                III-l

-------
                                         Estimated      Estimated
     Type of Cereal (cont'd)                Quantity        Value

     Hot Cereals^
        .  Farina & other wheat
        .  Rolled oats & oatmeal   1
        .  Other (incl.  undesignatedj
              Subtotal

              Total                       2,235.9            924.6
      - Estimate by DPRA


Implicit prices may be derived from the quantity/value data shown.  For
example,  the ready-to-eat cereals as a whole have an indicated value of
about $.448 per pound.  However, the reader is cautioned that these
product quantities and values include  interplant transfers.  Hence, com*
puted values tend to understate finished product values.  It is noted here
that an average value of $.50 per pound was estimated for use in the model
plant analysis, based largely on the Census data as reported.

Besides the basic product categories  identified above, it is stressed that
the cereal industry produces many breakfast cereal products, .in varying
package sizes and in similar, but differentiable, product forms.  Over
150 cereal brands have been produced in the last 20 years.

Ready-to-eat cereals,  which are generally produced from one or more
of the basic grains — corn, oats, wheat and rice, may be flaked, puffed,
extruded, or shredded. Also,  these cereals may be  coated or non-coated
with sprays of sugar, vitamins, minerals, etc. to fortify and/or sweeten
the product.

Natural cereals have recently been greatly expanded in production to meet
growing demands—especially adult markets.   However, this  segment is
not included herein because no process waste waters are generally in-
volved in manufacture.

la general terms, no more than 4 percent of the total crop of oats,  wheat,
  orn, rice or barley are used for cereal production.  Hence, the industry
  s neither constrained by nor dominantly influences these basic commodi-
  ies markets.

   c.r-racteristic  of the cereal breakfast food industry has been its aggress-
     ivertising and sales promotion programs.  To promote consumer

                                III-2

-------
preference for individual product brands,  cereal makers are reported to
spend about 13% of their cereal sales revenue for advertising.   Many new
products, especially breakfast cereals with relatively higher protein
content, have been introduced.

A related factor to this study is pending Federal  Trade  Commission
action against the four leading cereal companies, i.e. ,  Kellogg's,
General Mills, General  Foods,  and Quaker Oats.  FTC charged that these
firms had a shared monopoly, with over 90 percent of the ready-to-eat
cereal markets in the U.S.  FTC has alleged that numerous cereal brands,
differing only superficially in content,  have been introduced in order to
maintain market  shares.  Further, FTC also alleged that these cereal
makers used intensive trademark promotions, restrictive allocation of
shelf space,  and  misleading advertising on the merits of their products.

According to FTC, it is  claimed that industry practices have resulted in
artificially inflated prices, excessive profits, limitations on product
innovation, and a general lessening of  competition.   All of these factors
are said to be in  violation of Section 5  of the  Federal Trade Commission
Act.

Pending the outcome of these FTC actions, it is somewhat uncerta  n how
the major cereal companies will likely respond to proposed EPA guide-
lines.   The uncertainty is caused because  FTC actions might include
divestiture, requiring the sale of plants and equipment to cereal competitors.
Also, actions might include the licensing of brand names and trademarks
on a royalty-free basis for a  specified period of time, and/or the prohibi-
tion of future acquisitions and practices that could be construed as  anti-
competitive.

DPRA met with and corresponded with the Cereal Institute trade associa-
tion in relation to this study fox EPA.  The pending FTC actions were of
major concern to the industry and it was felt that a  composite response
regarding pertinent cost information was not warranted under the circum-
stances.  Hence, the model plant cost-synthesis approach as developed,
was taken.  Further information is desirable, but cost relationships are
generally veil-documented in published records.

2.  Wheat Starch Processing Segment

In extreme contrast, wheat starch processing involves manufacture of
starch and gluten from residual low-grade wheat flour ("clears" or
"second clears").  Virtually no product differentiation is made--although
different grades of starches are produced,  among plants.  For example,
given a  specified quantity of input, the  following approximate yields and

                                 III-3

-------
product values are obtained:

      Product/Input                         Percent   Value /Cwt-

      Flour Clears                            100
      Starch                                   70        $4-7
         .  Prime Pearl                       (28)
         .  Granules-                        (42)
      Vital Gluten                              14        $25-39
      Fat, Fiber, Soluble Protein I/            16
 ^'  DPRA estimated a composite value of sales of $10.36 per hundred-
    weight of flour  (clears) processed.
 —  Input for gelatinized starch (for corebinders, wallpaper paste, etc.)
    and distillers' products.
 \J  Used as distillers' products.  Value included with starch.

 As  noted, DPRA estimated an average value of sales of  $10.36 per cwt.
 of flour clears processed.  Starch prices vary generally due to prices
 of competing starches (primarily corn starch which comprises over 90
 percent of the industrial starch used in the U.S.).  Vital gluten is a highly
 valued ingredient in the baking industry,  both because of its generally
 high protein content, but perhaps more-so for baking quality enhancement
 features, e. g., improved texture and less breaking.

 Because of the exceptionally high proportion of raw material costs,  e.g. ,
 81  percent in processing relative to sales value, this industry  segment
 is especially sensitive to variations in wheat and related flour  costs.
 Also, little can be  done  to compete or change prices of starch, for ex-
 ample, unless changes first occur in  corn  starch prices.  However,
 vital wheat gluten prices may be changed independent of the starch prices,
 subject to demand  conditions  in the baking  industry. Other by-product
 values are generally minor.
                                    Ill-4

-------
                      B.   Potential Price Changes
With the proposed imposition of pollution controls and associated treat-
ment costs, an obvious question is whether impacted firms can likely
increase prices to recover incremental waste treatment costs.  In com-
petitive markets, an individual firm is not likely to raise prices unless
a high proportion of the industry is  likewise impacted.  (In some cases,
location advantages  or other special characteristics of individual plants
or products may permit individual adjustments  in prices,  e. g.,  wheat
starch processors are widely dispersed and some location price differen-
tials may be possible.)

As is later discussed (Chapter V), very few cereal or wheat starch plants
are directly affected by the proposed point source guidelines since es-
sentially all plants are on municipal systems. Hence, industry-wide price
increases are not expected in general due specifically to the direct dis-
charge guidelines.                 !

In addition, attention should be given to the availability  of close  substitute
products which might limit price changes even if all plants in  one industry
w.ere impacted.  In cereal manufacturing, there appear to be few compar-
able other packaged food products which would substitute readily.  How-
ever,  hot cooked and natural breakfast foods within the  same industry
would not be affected as much as RTE cereals by water effluent  controls.

 In the wheat starch  industry,  the  two main products are produced:  wheat
 starch and gluten.   In this case, wheat starch competes directly with
 corn starch (the dominant starch used in the U.S.), and, hence,  the
 industry as a whole cannot freely adjust prices to compensate for higher
 costs. On the other hand, vital wheat gluten products provide a rather
 unique high protein  foodstuff which  enhances food preparation quality
 (e.g., in baking and with texturized vegetable protein products). In this
 case,  price changes could more readily occur.

 The prospective price changes that are both "needed" to recover incre-
 mental pollution control costs and that are most likely within  each industry
 segment are discussed further in Chapter VI, below.
                                    m-s

-------
          IV.   ECONOMIC IMPACT ANALYSIS METHODOLOGY
The economic impact analysis will utilize the basic industry information
developed in Chapters I-III plus  the pollution abatement technology and
costs to be provided  by Environmental Protection Agency.  The impacts
to be  examined include:

                            Price effects
                            Financial effects
                            Production effects
                            Employment effects
                            Community effects
                            Other effects

The required impact analysis will not be a simple  sequential analysis
but rather will be composed of a number of interacting steps with feedback.
The schematic of the analytical  approach is shown in Figure IV-1.  Due
to the fundamental nature  of potential plant  shutdowns (financial and
production effects) to the other impacts, a disproportionate amount of
time  will  be  devoted  to the plant closure analysis.

The fundamental aspect of the impact analysis is similar to that  lormally
done  for any capital budgeting study of new  investments.  The problem is
one of deciding whether a  commitment of time or money to a project is
worthwhile in terms  of the expected benefits derived.  The problem is
complicated  by the fact  that benefits and investments will  accrue over a
period of time and that in  practice the analyst is not sufficiently clair-
voyant nor physically able to reflect all of the required information,
which by definition must deal with projections of the future.  In the face
of imperfect and incomplete information and time constraints,  the
industry segments described in  form of  financial budgets  of model plants.
Key non-quantifiable factors were incorporated into the analytical thought
process to interpret  the quantified data.  Actual  financial  results will
deviate from the model  results and these variances will be considered
in interpreting the findings based on model  plants.
                       A.  Fundamental Methodology
The fundamentals for analysis are basic to all impacts.  The core
methodology will be described here as a unit with the specific impact

                                  IV-1

-------
                                        Industry
             Industry
            Structure
            Industry
            Financial
              Data
                     Segmentation
                                      Model Plant
                                      Parameters
                                           V
                          Budget
                           Data
                        Development
                                            \V
                                         Model
                                        Financial
                                         Analyses
Industry
Pricing
                                               Financial
                                               Profiles
        EPA Pollution
         Control Costs
  Base
Closures
Plant Closures L
               l"**
Due to Control
          Employment
             Effects
          Community
            Effects
                           Price

J,
Shutdown
Analysis
J,
Production
Expected
Effects
J,
Foreign
Trade
Effects
"% -
/
•» f^

       7- 1.  Schematic   of impact analysis of effluent control guidelines.

-------
analysis discussed under the appropriate heading following this section.

The core analysis for this inquiry was based upon synthesizing physical
and financial characteristics of the various industry segments with or
representative (model)  plants.  Estimated financial profiles and cash
flows were presented in Chapter II.  The primary factors involved in
assessing the financial  and production impact of pollution control are
profitability changes, which are a function of the cost of pollution control
and the ability to pass along these costs in higher prices.  In reality,
closure decisions are seldom made on a set of well defined and documented
economic rules.   They  include a wide range of personal values,  external
forces such as the ability to obtain financing or considering the production
unit as an integrated part of a larger cost center where total costs must
be considered.

Such circumstances include but are not limited to the following factors:
                   I
        1.  A lack of knowledge on the part of the owner-opera tor
           concerning  the actual financial condition of the operation
           due to faulty or inadequate accounting systems or
           procedures.  This is especially likely to occur among
           small, indlependent operators who do not have effective
           cost accounting systems.

       2.  Plant and equipment are old and fully depreciated and the
           owner has no intention  of replacing or modernizing them.
           He continues production as  long as he can cover labor and
           materials costs and/or until the equipment deteriorates
           to an irrepairable and inoperative condition.

       3.  Personal values and goals associated with business owner-
           ship that override or ameliorate rational economic rules.
           This  complex of factors may be  referred to as a value of
           psychic income.

       4.  The plant is a part of a larger integrated entity and it
           either uses  raw materials being produced profitably in
           another of the firm's operating units wherein an assured
           market is critical or, alternatively, it supplies raw
           materials to another of the  firm's operations wherein
           the source of supply is  critical.  When the profitability
           of the second operation offsets the losses in the first
           plant, the unprofitable operation may continue indefinitely
           because the total enterprise is profitable.

                                   IV-3

-------
       5.  The owner-operator expects that losses are temporary
           and that adverse conditions will  dissipate in the future.
           His ability to absorb short-term losses depends upon his
           access to funds, through credit or personal resources
           not presently utilized in this particular operation.

       6.  There are very low (approaching zero) opportunity costs
           for the fixed assets and for the owner-operator's
           managerial skills and/or labor.  As long as the operator
           can meet labor  and materials costs, he will continue to
           operate.  He may even operate with gross revenues below
           variable costs until he  has exhausted his working capital
           and credit.

       7.  The value of the land on which the  plant is located is
           appreciating at  a rate sufficient  to offset short-term losses;
           funds are available to meet operating needs and opportunity
           costs of the owner-opera tor's  managerial skills are low.

These factors are generally associated with proprietorships and closely
held enterprises rather than publicly held  corporations.

While the above factors are present in and relevant to business decisions,
it is argued that common economic rules are sufficient to provide useful
and reliable insight into  potential business responses to required invest-
ment and operating costs in pollution control facilities.

The following discussion presumes investment in pollution control
facilities.  However,  the rules presented apply to on-going operations.
In the simplest case,  a plant will bie closed when variable expenses {Vcf}
are greater than revenues (R)  since by closing the plant, losses can be
avoided.

A more probable situation is where VC < R but revenues are less than
variable costs plus cash overhead  expenses  (TCc) which are fixed in
the  short run.  In  this situation a plant would likely continue to opera ^
as contributions are being made toward covering a portion of these
fixed cash overhead expenses.  The firm cannot operate indefinitely
under this condition,  but the length of this period is uncertain.  Basic to
this strategy of continuing operations is the  firm's expectation that
revenues will increase to cover cash outlay.   Identification of plants
where  TCc>  R, but Vc < R leads to an estimate of plants that should be
cl' sed over some  period of time if revenues do not increase.  However,
  *  timing of such closures  is  difficult to predict.

                                    IV-4

-------
The next level is where TCc < R. So long as TCc < R it is likely that
plant operations will continue so long as the capitalized value of earnings
(CV), at the firm's  (industry) cost of capital,  is greater than the realiz-
able-value (S) of sunk plant investment.  If S >CV or CV - S < O, the firm
could realize  S in cash and reinvest and be financially better  off, assum-
ing reinvesting at least at the firm's (industry) cost of capital.

Computation of CV involves discounting the future earning flows to
present value through the  discounting function:
            NPV   =   £      An (Hi)"n
                       n=l
            where

            NPV   =     net present value
            A      =     future after-tax income in n*h year or salvage
                         value in year t
            i       =     discount rate at cost of capital
            n      =     number of conversion periods, i. e. ,
                         1 year, 2 years,  etc.

'It should be noted that a more common measure of profitability is
return on investment (ROI) where profits are expressed as  a percent of
invested capital (book value),  net worth or sales.  These measures
should not be  viewed so much  as different estimates of profitability as
compared to present value measures but rather an entirely different
profitability concept.

The data requirements for ROI and NPV measures are derived from the
same basic financial information although the final inputs are handled
differently for each.
1.  Returns

For purposes of this analysis, returns for the ROI analysis have been
defined as pre-tax and after-tax income and for the NPV analysis after-
tax cash proceeds.  The computation of each is shown below;

        Pre-tax income      =     (R-E-I-D)

        After-tax income     =     (1 - T) x (R-E-I-D)

                              IV-5

-------
       where

           T   =   tax rate

           R   =   revenues

           E   =   expenses other than depreciation and interest

           I    =   interest expense

           D   =   depreciation charges

Interest in the cash proceeds computation is omitted  since it is reflected
in the discount rate, which is the after-tax cost of capital.  Depreciation
is included in the NPV measure only in terms of its tax effect and is then
added back to obtain cash flow.

A tax rate of 22 percent on the first $25,000 income and 48 percent on
amounts over $25, 000 was used throughout the analysis.  Accelerated
depreciation methods, investment credits, carry forward and carry back
provisions were  not used due to their complexity and special limitations.


2.  Investment
Investment is normally thought of as outlays for fixed assets and working
capital.  However, in evaluating closure of an on-going plant with sunk
investment,  the value of that investment is its liquidation or salvage value
(opportunity  cost or shadow price). \J  For this analysis, sunk investment
was taken as the sum of liquidation value of fixed assets plus net working
capital (current assets less current liabilities) tied up by the plant (see
Chapter  II for values).  This same amount was taken as a negative
investment in the terminal  year.

The rationale for using total shadow priced investment was that the cash
flows do not  include interest expenses  with interest charges reflecte " .n
the weighted cost of capital.  This procedure requires the use of tot^x
capital (salvage value) regardless  of source.  An alternative  would be to
use as investment, net cash realization (total less  debt retirement) upon
liquidation of the plant.  (In the single  plant firm debt retirement would
 -  This should not be confused with a simple buy-sell situation which
    merely involves a transfer of ownership from one firm to another.
    In this instance, the opportunity cost (shadow price) of the invest-
    ment may take on a different value.

                                    IV-6

-------
be clearly defined.  In the case of the multi-plant firm,  delineation of
debt by plant would likely not be clear.  Presumably this could be reflected
in proportioning total  debt to the individual plant on some plant parameter
such as capacity or  sales.)  Under this latter procedure, interest and
debt retirement costs would be included in the cash flows.

The two procedures will yield similar results if the cost of capital and
interest charges are estimated on a similar basis.  The former  procedure,
total salvage value,  was used as it gives reasonable answers and simpli-
fies both computation and explanation of the cash flows and salvage  values.

Replacement investment for plant maintenance was taken as equal to
annual depreciation, which corresponds to operating policies of  some
managements and serves as a good proxy for replacement in an  on-going
business.

Investment in pollution control facilities  will be from  estimates  provided
by EPA.  Only incremental values will be used,  to reflect in-place
facilities  and only the value of the land for control will be taken  as a
negative investment in the terminal year, i.e. , pollution control equip-
ment is assumed to  have no salvage value.

The above discussion refers primarily to the NPV analysis.  Investment
used in estimating ROI was  taken as invested capital — book value of
assets plus net working capital.
 3.  Cost of Capital - After Tax

 Return on invested capital is a fundamental notion in U. S. business.
 It provides both a measure of actual performance of a firm as well as
 expected  performance.  In this latter case, it is also  called the cost of
 capital.  The cost of capital is defined as the weighted average of the
 cost of each type  of capital employed by the firm, in general terms
 equities and interest bearing liabilities.  There is no  methodology that
 yields the precise cost of capital, but it can be approximated within
 resonable bounds.

 The cost of equities was estimated by the dividend yield method which is
 a simplification of the more complex NPV methodology.  The dividend
 method is:
                                 IV-7

-------
                k    =   p-  +g

        where
                k    =   cost of capital
                D   =   dividend yield
                P   =   stock price
                g    =   growth


The after tax cost of debt capital was estimated from reported (annual
financial reports and financial statistics) company outlays for interest
expenses and multiplying by . 52 - - assuming a 48 percent tax rate.
These values were weighted by the  respective equity to total asset and
total liabilities— to total asset ratios.

Estimated cost of capital for the industries under study are contained
in Chapter II.
_4.  Construction of the Cash Flow

The cash flow to be used  in the analysis of BPT (Best Practical Tech-
nology) and BAT (Best Available Technology) effluent control and will be
constructed as follows:
        1.  Sunk investment (salvage market value of fixed assets
           plus net working capital) taken in year t  ,  assumed to
           equivalent to  1976,

       2.  After tax cash proceeds taken for years t, to t
— It is recognized that liabilities contain non-interest bearin" liabilities
   but its v. eight is believed to be an adequate proxy for the weight of
   debt.

                                   IV-8

-------
       3.  Annual replacement investment, equal to annual current
           depreciation taken for years t  to tR.

       4.  Terminal value equal to sunk investment taken in year tn.

       5.  Incremental pollution control investment taken in year t
           for 1977 standards and year t, for 1983 standards.
       6.  Incremental pollution expenses taken for years t. to tn
           for 1977 standards and years t 1
           if additive to the 1977 standards.
for 1977 standards and years t  to t  for 1983 standards.
       7.  Replacement investment taken in year t  on incremental
           pollution investment in BPT on assumption of life of
           facilities as provided by EPA.

       8.  No terminal value of pollution facilities to be taken in year t .
           Land value will probably be assumed to be very small and/or
           zero, unless the costs provided indicate otherwise.

The length of the cash flow will depend upon the  life of the pollution control
technology provided by EPA.  It is anticipated that  the length of fhe cash
flow will be equal to the life of control  equipment specified for  I1. 83
installation.

Construction of the cash flows for analyzing new source standards  will be
similar to BPT and BAT,  excepting plant investments,  costs and returns
will be based on current values as if being built  now.
                          B.   Price Effects
As shown in Figure IV-1,  price and production effects are interrelated
with each having an impact upon the other.  In fact, the very basis of
price analysis  is the  premise that prices and supplies (production) are
functionally related variables which are simultaneously resolved, thus
the feedback loop shown in Figure IV- 1.

Solution of this requires knowledge of demand growth, price elasticities,
supply elasticities, the degree to which regional markets exist, the
degree  of dominance  exerted by large firms in the industry, market
concentration exhibited by both the industry's  suppliers of inputs and

                                   IV-9

-------
purchasers of outputs, organization and coordination within the industry*
relationship of domestic output with the world market,  existence and
nature of complementary goods, cyclical trends in the  industry, current
utilization of capacity and,  exogenous influences upon price determination
(e. g., governmental regulation).

In view of the complexity and diversity  of factors involved in determina-
tion of the market price, a purely quantitative approach to  the problem
of price effects will not be  feasible for  this study.  Hence,  the simul-
taneous considerations suggested above will be made.  The judgment
factor will be heavily employed in determining the  supply response to a
price change and alternative price changes  to be employed.

Application of the above NPV procedure to pollution control costs will
yield the present value of pollution control costs (i. e. ,  investment plus
operating cost less tax savings excluding interest expenses).  Given this,
the price increase required to pay for pollution control can be calculated
as
                                 (PVP) (100)
                    P   =        (1-T) (PVR)

       where:

                    P   =    required percentage  increase in price

                 PVP  =    present value of pollution control  costs

                 PVR  =    present value of gross revenue (sales)
                             starting in the year pollution  control
                             is imposed

                    T   =    tax rate appropriate following imposition
                             of pollution control

The next  step would be to evaluate the required price increases again  '-
expectations regarding the  ability to raise  prices.  As  pointed out above,
this v.'ill be a function of a  number of factor.?.  In cases where a few
large plants represent the bulk of production, their required price in-
crease will likely set the upper limit. For some products in this
study, other factors will be overriding.  For example,  wheat starch
                               IV-10

-------
price changes are largely constrained by competitive product, e.g.,
corn starch, price changes.  Also, relative pollution control cost im-
pacts on the segments studied vs.  other industries are important.  From
this analysis, which will be quantitative, an initial estimate  of expected
price increases would be made.

Following this,  the initial shutdown analysis  (production curtailment) will
be made.  The decrease in production will be evaluated in light of impact
on prices and if warranted by production decreases, the expected price
increase would be revised upward.
                      C.   Shutdown Analysis
The basic shutdown analysis would be based upon the technique described
above under Section A and the expected price increase from the preceding
step.   In addition to this analysis, analyses would also be made to estab-
lish estimated plant closures without imposition of pollution control, or
so-called "base line" closures.  This analysis would involve the same
financial analysis technique, without pollution control, and  factoring in
other information such as  trends in the industry itself and in competing
products.

Based on the results  of the NPV analysis of model plants, likely closures
would be identified  where NPV 
-------
                      D.  Production Effects
Potential production effects include changes of capacity utilization rates,
plant closures and stagnation of industry growth.  Plant closures may be
offset in total or in part by increases in capacity utilization on the part
of plants  remaining in operation.   Expected new production facilities
would be  estimated.  The end result would be estimated production under
the conditions presumed for the above closure analysis.

The estimated production under these expectations would feedback into
the price analysis to verify or revise expected price changes.
                     E.   Employment Effects
Given the production effects of estimated production curtailments, potential
plant closings and changes in industry growth, a major consideration arises
in the implications of these factors upon employment in the industry.   The
employment effects  stemming from each of these production impacts in terms
of jobs lost will be estimated using the model plant information.

Locations of closed plants with respect to their importance to locations
labor base will be evaluated.  This analysis would be directed toward
re-employment  potentials.
                      F.  Community Effects
The direct impacts of job losses upon a community are immediately ap-
parent.  However, in many cases, plant closures and cutbacks have a far
greater impact than just the employment loss.  These multiplier effects
will be reflected in evaluating payroll losses and income multipliers.

In addition to these direct and indirect impacts on communities, broader
potential impacts must be evaluated.  The  criticality of the industry seg-
ments throughout the economy will be assessed.
                         G.   Other Effects
Other impacts such as  direct balance of payments effects will also be
included in the analysis.   This will involve qualitative analyses.

                                 IV-12

-------
     V.  POLLUTION CONTROL REQUIREMENTS AND COSTS
The water pollution control standards, technology, and costs used in
this analysis were furnished by the Effluent Guidelines Division of the
Environmental Protection Agency from materials developed in part
for the Environmental Protection Agency by Sverdrup and Parcel and
Associates (S&P).  The basic data constructed by S&P were adapted
to the types and sizes of plants  designated in this analysis.

Three effluent guidelines were considered:

       BPT     -   Best Practicable Control  Technology Currently
                    Available,  to be achieved by July 1, 1977

       BAT     -   Best Available  Pollution Control Technology
                    Economically Achievable,  to be achieved by
                    July 1, 1983

       NSPS    -   New Source Performance Standards, apply to any
                    source for which construction starts after the pub-
                    lication of the proposed regulations  for the Standards

A technical document describing the recommended technology for
achieving the  three guidelines will be published as a separate report
by EPA.  To avoid duplication and possible confusion, no technical
descriptions of BPT, BAT  and NSPS guidelines are given in this  report.
The interested reader is referred to EPA's technical report for tech-
nology descriptions.
                A.   Pollution Control Requirements


The Best Practicable Control Technology currently available (BPT) and
the Best Available Technology (BAT) tentative guidelines proposed for
cereal breakfast foods and wheat starch processing subcategories of the
grain milling industry are summarized in Tables V-l  and V-2 respectively.
Also NSPS guidelines are shown in Tablve V-3 and these guidelines are
applicable for new plants which are  constructed after  promulgation of the
proposed standards.

Achievement of the BPT and BAT proposed guidelines would necessitate
the application of suitable treatment practices. In the draft Development
Document by S&P specific possible waste water treatment practices were
identified for each subcategory of the grain milling industry being studied
to achieve effluent reductions corresponding to both BPT and BAT levels.

                               V-l

-------
    Table V -1.   BPT pollution control:  effluent reduction attainable
     through the application of best practicable control technology
                         currently available

                         	BPT proposed standards
                        BOD            Suspended solids
Industry Segment  (lbs/1000 Ibs.)         (lbs/1000 Ibs.)           pH

Ready-to-eat
cereal manufacturing    0.40                 0.40               6-9

Wheat starch and
gluten manufacturing    2.0                  2.0                6-9
Source: EPA and Sverdrup & Parcel and Associates
    Table V-2.   BAT pollution control: effluent reduction attainable
     through the application of best available technology economically
                            achievable
                                  BAT proposed standards
                         BOD           Suspended solids
Industry Segment  (lbs/1000 Ibs. )         {lbs/1000 Ibs. )           pH
Ready-to-eat
cereal manufacturing     0.20                 0.15              ->-°

Wheat starch and
gluten manufacturing     0.50                 0.40              6-9


Source:  EPA  and Sverdrup & Parcel and Associates
                               V-2

-------
 Table V-3.  NSPS pollution control: effluent reduction attainable
              through the application of New Source       >              .j
                   Performance Standards 2.'

                                 	NSPS Proposed Standards
                                      BOD       Suspended Solids
Industry Segment	(Ibs/I.OOP Ibs)  (Ibs/I,OOP Ibs)    pH

Ready-to-eat cereal
manufacturing                        0.20             0.15         6-9

Wheat starch and gluten
manufacturing                        1.00            ' 1.00         6-;9
Source: EPA and Sverdrup and Parcel and Associates


—  BPT and BAT technologies were applied in the impact analysis to
   estimate achievement of these standards.
                             V-3

-------
In each case, the BAT proposed practices assumed compliance with the
BPT practices  initially, followed by additional treatment to attain the
higher standard.

A brief summary of indicated treatment practices proposed to meet the
tentative guidelines by corresponding industry subcategory is presented
below.

1.  Ready-to-eat Cereal Manufacturing

General Requirements - Those plants  discharging directly to surface
waters must undertake major pollution abatement activities to meet
effluent limitations.  Since the majority of waste waters from ready-to-
eat cereal manufacturing are  generated by clean-up operations, the
influence upon  raw waste characteristics through the use of in-plant
controls is not anticipated.  Treatment of the entire waste water stream
will be necessary as follows:

        1.   Collection and equalization of flow
       2.   Primary sedimentation
       3.   Nutrient addition
       4.   Biological treatment using activated sludge or a comparable
            system
       5.   Secondary sedimentation

Waste loads could be reduced in some plants if a larger degree of dry type
clean-up operations were employed, e.g., sweeping and vacuuming instead
of wet washing methods.  The waste water treatment practices proposed
to meet the  proposed guidelines are basically as follows:

       (1) BPT: Equalization and Activated Sludge - Treatment con-
       sists of an aerated equalization step with 18-hour detention
       ahead of the  complete-mix activated sludge system and assoc-
       iated chemical feed, sedimentation, and sludge dewatexing
       facilities. (Treatment alternative "B"  as reported by EPA)

       (II) BAT:  Equalization, Activated  Sludge, and Deep Bed
       Filtration - Treatment consists of BPT treatment plus deep
       fed filtration. (Treatment alternative "D" as reported by EPA)

Industry Experience - At present, only one cereal plant has a direct dis-
charge of process  waters to surface waters, and that waste discharge is
not treated.  That particular plant's municipal sewer system is being
expanded and will  collect these waters for treatment in the near future.
AI\ other cereal plants  studied discharge their wastes to municipal
systems.

                                V-4

-------
Several plants furnish minimal forms of pretreatment for process waters
prior to discharge to municipal systems*  This preliminary treatment
usually consists of screening and occasionally settling and skimming.
Collected solids are either recovered and  dried as animal feed or dis-
posed of by landfill.

One plant in the industry currently provides more extensive pretreatment
prior to discharge into a municipal system.  This biological pretreatment
system consists of a one and one-fourth acre  lagoon equipped with mechan-
ical aerators and is  designed for thirty day detention.  Nutrients  in the
form of ammonia and phosphoric acid are  added to the high carbohydrate
waste stream.  All process and sanitary wastes from the plant, including
shredded cereal cooking wastes, are treated by the facility.

Another  small RTE  cereal plant is currently constructing a pretreatment
facility designed to treat combined process and sanitary wastes.  The
facility will consist  of two aerated lagoons in  series with nutrient addi-
tion and provision for recycling between the two lagoons.  Additional
technical data concerning these latter two  plants is presented in the
S & P's Development Document for EPA.

Since RTE waste waters have been determined to be compatible with
municipal system requirements, there  are no federal prerequisites for
discharge into municipal systems (although local and state laws may
require pretreatment.) However,  as external waste water treatment
charges  increase (primarily1 due to charges by municipalities when
existing  systems are upgraded) external pretreatment facilities are
likely in order to reduce this cost burden.
                          i
Z.  Wheat Starch and Gluten Manufacturing


 General Requirements - It is doubtful  that any major reductions  in waste
 loads can be achieved through in-plant controls or modifications  at existing
 starch plants.   Treatment of the entire waste stream will be required as
 follows to meet the  effluent limitations:

        1.  Collection and equalization of flow
        2.  pH neutralization
        3.  Primary sedimentation
        4.  Biological treatment using activated sludge or a comparable
            system
        5.  Final separation of solids by sedimentation prior to discharge

Since product yield  is economically crucial to wheat starch and gluten plants,
most manufacturers already attempt to maximize  solids recovery in the
starch refining operations by thickening and centrifugation.  To meet the
proposed effluent guidelines,  the  treatment practices recommended are
as follows:
                               V-5

-------
    (I)  BPT: Equalization and Activated Sludge - Treatment includes
    18 hours of aerated equalization ahead of the complete-mix sludge
    system.  (Treatment alternative "B" as reported by EPA.)

    (II)  BAT:  Equalization,  Activated Sludge, and Deep Water
    Filtration^In this proposed system, deep water filtration is
    added to the proposed BPT system above.  (Treatment alternative
    "D" as reported by EPA.)

Industry Experience - Of the seven wheat starch and gluten manufacturing
plants,  six plants discharge their wastes to municipal systems. One of
these six plants provides pretreatment,  and another is building a pre~
treatment facility.  The seventh plant uses its starch effluent in a  dis-
tillery operation from which there is a direct discharge to a surface
water.  (This plant is  constructing a treatment plant for the distillery
wastes.)  Two new  plants will commence operation  in the near future,
and both anticipate  the generation of much lower volumes of waste water
than existing plants.  One plant will accomplish this by drastically re-
ducing water requirements, while the other hopes to employ a total recycle
system.

Discussions by DPRA  with industry  representatives have indicated a grow-
ing and widespread concern within the industry that municipal system treat-
ment charges are expected to increase sharply in the future, e.g. ,, about
a three-fold increase on average. Hence, the industry as a whole is eval-
uating both pretreatment and private treatment systems which might be
used to augment and/or replace municipal treatment systems for a lower
average treatment  cost over time.
                B.  "Typical" Effluent Control Costs
 The additional investment and operating costs required of a "typical"
 in each plant-size and segment group, to achieve indicated perforiaaaace
 standards were specified in the Development Document.  Typical plaats,, as
 defined by EPA, are indicated as follows:

 In the ready-to-eat cereal segment, a wide range of plant production
 capacities exists.  Therefore three hypothetical plants were constructed
 with the following capacities:

        1.  A "small" plant with a  capacity of 200,000 pounds per day.
        2.  A "medium" plant with a  capacity of 500,000 pounds per day.
        3.  A "large" plant with a capacity of 1,200,000 pounds per day.
                                 V-6

-------
These three plant sizes are considered representative of the ready-to-
eat subsegment of the cereal breakfast food industry.  In the small
plant capacity range, (50,000 pounds per day to 300,000 pounds per day)
those plants nearer 50,000 pounds per day capacity are typically natural
and hot  cereal plants.  For this reason, a  plant of near the lower extreme
of the small plant capacity range was not included in this analysis.

Also , the largest plants are commonly referred to as  super size plants.
Kellogg and Post plants are examples of super size  operations with both
producing over 1,000,000 pounds per day (estimated production is be-
tween 1, 000,000 and 1,400,000 pounds per day).

The  seven wheat starch and gluten plants demonstrate a narrow range of
plant capacities.  Therefore one hypothetical plant was constructed with
the following characteristics:
       1.  One plant with an average daily raw material capacity of
           100,000 pounds  of flour.

The additional investment required by "typical" plants to achieve the in-
dicated performance standards is shown in Table V-4.   The model plants
were  selected as the most representative impacted size categories of
plants, and it is believed that representative plant data, as provided,  are
adequate to project the overall expected impacts.
                              V-7

-------
      Table V-3.  Incremental effluent  control costs for "typical"
       ready-to-eat cereal, and wheat  starch and gluten plants
BPT I/ BAT */

Plant size
Ready -to-eat ce
Small
(200,000
Medium
(500,000
Large

Investment
real:
527,900
Ibs/day)
811, 800
Ibs/day)
1,277, 500
Annual oper.,-.
ating costs — Investment

58,000 35,400

93,700 63,500

148,100 134,200
Annual <• >
ating costs

8,000

15,600

25,800
(1,200,000 Ibs/day)
Wheat starch & gluten:

   Medium                    964,300       126,900      31,700       7,600
      (1,000 cwt/day)
Sources:  Compiled by DPRA from data provided by EPA as reported in the
S fc P Developn ent Document.

—  L.TT and BAT controls were briefly described in the text.  In botn tl.e
   RTE and the wheat starch processing segments, BPT control co-.t^
   refer to the ,1 Iternative "B" treatment strategy and BAT control < i. st*
   refer to tlv alternative "D" treatment strategy as  contained in th<_-
   Development Document.   BAT costs are incremental above BPT cos u
   as shown.

?/ Annual operating costs include operating and  maintenance costs plus
   energy and power costs as shown in the Development Document.   Interes'
   (capital) costs and  depreciation are not included.
                               V-8

-------
                     VI.   IMPACT ANALYSIS
The imposition of direct discharge effluent guidelines on the  ready-to-eat
cereal manufacturing and wheat starch and gluten manufacturing industries
are not likely to have significant direct impacts on either industry.  The
principal reason for this is that the     majority of existing firms in both
industries currently discharge waste waters into municipal sewer systems
where treatment of these wastes can be adequately performed.

With the exception of one wheat starch plant, all plants in this segment
are currently connected to municipal waste treatment facilities and are
paying associated user charges.  (For the single plant with a direct dis-
charge, the starch effluent is first used in a distillery operation.  Wastes
from  the distillery operation are discharged to a receiving water.  This
combined plant is now constructing a treatment facility for the wastes.)
However, other plants may leave municipal systems for  at least two
reasons:  (1) the municipal system may refuse continued service to these
plants, or (2) plant management may choose to provide their own treatment
with the anticipation of lower overall treatment costs in the long-run as
compared to prospective municipal system costs.  In either case, the  focus
of this analysis would indicate prospective economic impacts associated '
with installing BPT and BAT treatment systems as  proposed.

As was indicated in the preceding chapter, only one  cereal plant was
reported to have a direct discharge of process wastes to a receiving
water (untreated).  It was further noted that the city's municipal sewer
system is being expanded to collect the wastes in the near future.

The proposed "BPT" and "BAT" standards will therefore apply to only one
plant  (or soon none) in each industry. However, consideration is  given to
the potential impact of New Source Performance Standards (NSPS) which
would apply to any new firms  entering these industries.  In this  case,  the
wheat starch processing industry is seriously affected.

For purposes of this study, the NSPS standards are assumed equal to the
BAT standards and the  estimated costs for BAT are subsequently used for
assessing the new source potential impacts.

The ready-to-eat cereal and wheat starch manufacturing segments are
discussed separately according to the following impact types:

        .  Price effects
        .  Financial effects
        .  Production effects
        .  Employment effects
          Community effects
        .  Balance of payment effects

-------
Because of the limited applicability of the proposed effluent guidelines,
the above effects are expected to be minimal.  Attention will be devoted,
therefore, to the model plant financial analyses.  In general,  neither
industry as a whole will likely be adversely impacted by the proposed
standards and associated treatment requirements.
               A.   Cereal Breakfast Food Segment


As an overview,  the following factors are pertinent to this analysis:

        .  Only 1 of 17 existing RTE cereal plants currently discharges
          directly  into surface waters.

          The single plant disposing of wastes directly into surface
          waters will connect with the municipal sewer system wh,ich
          is in the process of expanding capacity to handle tjie con-
          nection.

          Plant  sizes range from about 200, 000 pounds per day to well over
          1,000,000 pounds per day capacity.

          Four firms dominate the  U.S. cereal industry with over
          90 percent of the U.S. total sales of cereal products.

        .  Since  16 of 17 existing plants (soon all 17)  discharge waste
          waters into municipal systems,  any expected effluent contrpl
          impact will have occurred via treatment practices in place
          prior  to the enforcement of the proposed effluent guidelines,

 1.   Price Effects
 Based upon the individual model plant analyses, the required price in-
 creases to recover the costs of constructing and operating pollution con
 trol facilities are illustrated in Table VI-1.  These price changes were
 calculated as a percent of sales,  using a 21-year cash flow.  Both treat-
 ment costs and revenues were discounted back to year "zero" prior to
 calculating the  percentage price increase required.  This increase in-
 dicated the change necessary to keep the net present value (NPV) of the
 plant constant.   Price increases  required to recover the costs of BPT
 controls are relatively minor,  ranging from .26 percent for the large
 plant to .62  percent for the  small plant.   Price increases required for
 the medium  size plants would equal about .4 percent.


                                VI-2

-------
Table VI-1.  Percent price increase required to pay for incremental
             pollution control, cereal breakfast food industry.

                              BPT              BAT       BAT
                              above            above       above
Size of Plant                 Baseline         Baseline      BPT
                               (%J              TOTO
Cereal breakfast food:

   Small                      .62               .65          .03

   Medium                    .39               .41          .02

   Large                      .26               .28          .02
                              VI-3

-------
Price increases above BPT standards to recover the costs of BAT
standards are negligible, ranging from  .02 percent for the large plants
to .03 percent for the small size plants.

In that only one plant is potentially impacted (and that plant will eventu-
ally discharge into a municipal system), industry prices are not ex-
pected to increase  due to the imposition of direct discharge controls
on the RTE cereal  industry. Competition within the industry should
overshadow any prospective price change by an individual plant.

In a related matter, however,  numerous existing plants may face
higher treatment charges as municipal systems are  upgraded to meet
more stringent standards.  Any higher costs for municipal treatment
systems are expected to be passed on to users via higher rates and/or
surcharges. In such an instance industry-wide cereal prices might be
increased.

It is also noted that existing firms  are evaluating pretreatment systems
as a means of avoiding  prospective surcharges for treatment of industrial
wastes.  While there is no federal requirement for installing pretreatment
systems (because cereal wastes are  generally compatible with municipal'
waste treatment) some  state and local regulations may  necessitate pre-
treatment or make pretreatment economically feasible  in the near future.

2.  Financial Effects
Two primary types of analyses were completed to assess the financial
impacts of the proposed pollution control costs on the model plants: (1)
profitability impacts  and (2) impacts on the present value of future net
income stream.

Profitability impacts include the following:

          Pre-tax net income
          After-tax return on sales
        .  Pre-tax rate of return on invested capital
          After-tax rate of  return on invested capital
          Annual cash flow
                               VI-4

-------
Basic industry information and model plant financial profiles of the
RTE cereal subsegment, as presented in Chapter II, provide the
basis for assessing these profitability impacts.

Pre-tax income
The impact of alternative effluent treatment level on pre-tax net income
for model cereal plants is illustrated in Table VI-2.  The reduction in
pre-tax net income due to the imposition of BPT  and BAT standards
ranges from 1.0 percent in the large  plant to a 3. 3 percent reduction
in the small cereal plant.  After-tax income reductions are comparable,
ranging from about .9 percent to 2.9  percent for the same plants.

Return on sales

The after-tax return on sales for model cereal plants is illustrated in
Table VI-3.  With the imposition of BPT and BAT standards,  it can be
seen that the reduction in after-tax return on sales ranges from  0. 1
percent in the large plant to 0.3 percent in the  small.  Incomes as a
percent of sales for all three plant sizes are negligibly reduced with the
imposition of these standards.

Return on invested capital

Return on invested capital before and after tax for model cereal plants
is illustrated in Table VI-4.  The high after-tax  rate of  return on invested
capital demonstrates exceptional profitability of the cereal breakfast food
industry.  After tax income as a percent of invested capital ranges from
a high of 20. 5 percent in the large size plant to a low of 12.0  percent for
the small size plant.

With the imposition of the BPT and BAT Standards  after-tax return on
invested capital declines 0.7 percent  in the small plant and 0.6  percent
in the large plant.  Again this  is not a decline that would be damaging.

Cash flow

Estimated cash flows (after-tax income plus depreciation) for the model
cereal plants are illustrated in Table  VI-5. Cash flows,  at baseline,
range from 16.6  percent of average invested capital for  the small plant
to 25.4 percent for the large plant. Cash flows are not adversely affected,
after the imposition of the BPT and BAT standards.
                               VI-5

-------
     Table VI-2.   Pre-tax and after-tax income for model cereal plants, assuming no price change
Size of Plant

Cereal breakfast food:
Small
Medium
Large
Pre-tax Income
Baseline
($000)

3, 583
11, 857
29,718
BPT
($000)

3,478
11,690
29,455
BAT
($000)

3,466
11,669
29,417
After-tax Income
Baseline
($000)

1, 863
6, 166
15,453
BPT
($000)

1,815
6,085
15,323
BAT
($660)

1,809
6,074
15,303
I
a-

-------
Table VI-3.  Pre-tax and after-tax return on sales for model cereal plants, assuming no price change



<
-J

Size of Plant
Cereal breakfast food:
Small

Medium
Large

Baseline
(%)
15.3

20. 3
21.2
Pre-tax Income
BPT
(%)
14.9

20.0
21.0

BAT
(%)
14.8

19-9
21.0

After-tax Income
Baseline BPT
(%)
8.0

10. 5
11.0
(%)
7.8

10.4
10.9

BAT
(%)
7.7

10.4
10.9

-------
oo
     Table VI~4.   pre-tax and after-tax rate  of return as a percent of average invested capital for model
                                       cereal plants, assuming no price change.
Size of Plant
Cereal breakfast food:
Small
Medium
Large

Baseline
(%)
23.2
35.4
39.4
Pre-tax
BPT
(%)
21.7
34.1
38.4
Inc ome
BAT
(%)
21.6
33.9
38.2
After-tax Income
Baseline BPT
<%) (*)
12.0 11.3
18.4 17.7
20.5 20.0

BAT
(%)
11.3
17.7
19.9

-------
Table VI-5.  Estimated cash flow on average invested capital for model cereal
     plants, alternative effluent treatment levels assuming no price change.
Type fc Size of Plant       Baseline	BPT              BAT

Cereal breakfast food:

   Small               2.563     16.6   2.541     16.4    2.537   16.4

   Medium             7.762     23.2   7,722     23.1    7,714   23.0

   Large              19.151     25.4  19,085     25.3   19,072   25.3
                                VI-9

-------
Net present value (NPV)

Another measure of financial viability of a plant is the net present value
(NPV) of projected streams of cost and  revenues.  Using this analysis,
it is possible to assess the likelihood of continued plant operation versus
plant closure.  In discounting the cash flow using a discount rate equivalent
to the firms cost of capital, positive NPV's would indicate the likelihood
of continued plant operation whereas negative NPV's would infer a probable
plant closure.  To  complete this analysis, the following assumptions were
made.

        1. The  existing plants have  sunk investments but they could b«
          disposed of today for a salvage value and reinvested elsewhere
          if their cereal function were discontinued.  However, only 10
          percent of the estimated  replacement cost is assumed recoverable
          for this industry.  This relatively  low value is  estimated because
          cereal plants are moderately capital intensive and equipment
          would  have little salvage value  in alternative uses outside the
          industry.

        2. Revenues and expenses are assumed to remain constant
          over time,  i.e. , 20 years of  operation.


        3.   The estimated cost of capital for the industry is 9,0 percent.
            The net present value of model cereal plants before aztd after
           the imposition of alternative effluent treatment standards are
            shown in Table VI-6.

Since NPV's of all examined plants are  positive, the above analysis indi-
cates that all respective plants are expected  to be capable of bearing the
cost of both BPT and BAT controls.  No plant closures, due to the cost of
pollution abatement,  were suggested by this model plant analysts.

The fact that sixteen of seventeen existing plants discharge waste waters
to municipal systems is a direct indication that no plants  are likely to
shutdown due to pollution control requirements, per se.
                                VI-10

-------
Table VI-6.   Net present values of model cereal plants before and after the imposition of alternative
                                        effluent treatment standards.
BPT
Size
of
Plant

Small
Medium
Large
NPV of
Plant Before
Controls
($000)
13,080
48,613
124,469
NPV of
BPT
Controls
($000)
- 687
-1,078
-1,700
NPV of
Plant After
Controls
($000)
12,393
47,535
122,769
NPV of
BAT
Controls
($000)
- 36
- 68
-127
BAT
NPV of
Plant After
Controls
($000)
12,357
47,467
122,642

-------
3.  NSPS Effects

Another effect of environmental controls on the cereal industry in the
increased cost burden for new plants in the  industry and potentially
lower industry growth through time.  NSPS, new source performance
standards, if applicable, would be a partial deterrent to entry.

To assess probable impacts on a new  plant, replacement investment
costs (versus book value investment costs) are used to perform similar
profitability analyses as shown above.  New plants entering the industry
are expected to realize a lower after-tax rate of  return on invested
capital  (ROI).  Also,  lower net present values (NPV) are expected.
Comparative ROI and NPV data for the tnree RTE model plants  as  shown
in Table VI-7 illustrate these effects.  The new source model plants
remain economically viable following the imposition of BAT control
standards.

4.  Other Effects

The remaining types of impacts--production effects, employment effects.,
community effects  and balance-of-payment effects -- are considered
insignificant due to the nature  of this industry. Sixteen of the seventeen
existing plants, as reported in the Development Document L'  are
not affected directly by the guidelines of this study, although it should be
noted that these plants may incur an increase  in the cost of  operation
due to increased surcharges from their respective municipal plants.
              B.   Wheat Starch Processing Segment
As background for assessing the expected economic impacts of water
pollution controls on this industry, the following factors are highlighted:
—  Development Document for Proposed Effluent Limitations Guidelines and
   New Source  Performance Standards  for the Animal Feed,  Breakfast Cereal ,
   and Wheat Starch,  prepared by Sverdrup & Parcel and Associates,  Inc. for
   United States Environmental Protection Agency,  April,  1974.
                               VI-12

-------
Table VI-7.  Existing plants vs.  new source plants with BAT controls,
             returns on invested capital (ROI) and net  present values
                     (NPV), assuming no price increases.
Plant Size
 Existing Plants
ROI        NPV
 (%)       ($000)
   New Plants
 ROI        NPV
  (%)       ($000)
    Small

    Medium

    Large
12.0      13,080

18.4      48,613

20.5     124,469
 8.3
12.8
14.2
 1,877
23,550
67,172
                              VI-13

-------
          Of the seven wheat starch gluten manufacturing plants,
          six plants currently discharge their wastes to municipal
          systems.

          Wheat starch plants connected to municipal systems expect
          to be faced with significant treatment cost increases as
          municipalities upgrade their systems.

          The seventh plant  uses its  starch effluent in a distillery
          operation from which there is a direct discharge to a
          surface water.  Some question exists as to whether this plant
          falls under the guidelines proposed for wheat starch processors
          or under those for a distillery operation (it is also in the pro-
          cess of building a  treatment plant for the distillery wastes).

          The seven existing plants exhibit a fairly narrow range of
          plant capacities (50,000  Ibs to 150,000 Ibs) of flour pro-
          cessed per day and have similar waste water character-
          istics.  Our "typical" model plant has an average daily raw
          material capacity  of 100,000 Ibs of flour.

          Major wheat starch processing firms typically have large,
          diversified operations,  and wheat starch processing is a
          relatively small part of the total corporate business.

          Little can be done to increase  prices of wheat starch unless
          changes first occur in corn starch prices (corn starch com-
          prises over 90 percent of the U.S. starch usage).

With six of seven  existing wheat starch plants currently discharging
waste waters into municipal  systems,  the existing industry as a whole
should not be directly affected adversely by the proposed point-source
effluent guidelines.  The  impact issue  is clouded over,  however, be-
cause the proposed guidelines and associated costs would cause severe
impacts  on new sources  and/or any plant which might economically pre-
fer to discontinue its municipal hook-up.

The latter alternative has been under consideration by plant managers
in the industry because of higher projected municipal treatment charges,
although private treatment costs as estimated in this report appear pro-
hibitive for  existing plants.  As noted elsewhere, technological improve-
ments  in wheat starch-gluten processing increase  the risks of added
                                VI-14

-------
 capital expenditures within existing plants due to potential rapid obso-
 lescence of prevalent technology.  Another related concern of industry
 representatives is that the proposed treatment technologies have not
 yet been demonstrated within the industry.  This adds to the overall
 uncertainty with which the industry is faced.  In essence, the industry
 is relatively more concerned with the proposed point-source guide-
 lines than would at first appear warranted, -i'

 1.   Price Effects
 Based on the individual model plant analysis,  the required price in-
 crease to recover the costs of incremental pollution facilities is illus-
 trated in Table VI-8.   Price changes were calculated using a 21-year
 cash flow with treatment costs and revenues being discounted back to
 year "zero" prior to calculating the  percentage price increase required.
 This increase indicates the change necessary to maintain a constant
 plant net present  value (NPV).

 The price increase  required to achieve BPT standards,  according to the
 model plant analysis,  is approximately 8.7  percent for the medium size
 model plant. An  additional incremental price increase of 0.2 percent is
 required for subsequent implementation of the BAT standards.

 An individual plant in  the wheat starch processing industry would not
 be expected to pass-through cost increases  of the magnitude indicated,
 i. e., about  9 percent. However,  with essentially all plants  anticipating
 higher waste treatment charges,  some  price increases are likely. The
 impacts of  1, 3 and 5  percent price increases are evaluated in the financial
 and NPV sections below to indicate how price  increases might alter a
 firm's decision to continue operation.  Also, it is proposed that  a price
 increase of about 5  percent would be possible  under anticipated prospects
 throughout the industry.
       t

 The prospective 5 percent average price increase is based on both supply
and demand factors.  On the cost of production (supply) side, it is expected
that a three-fold increase in municipal waste treatment charges (from a
base level of about $30,000 to $40,000 average for a medium plant size)
will occur.   This  corresponds to a 3  to 4 percent increase in average sales
prices to recover  these added costs.  Hence, industry price increases of this
magnitude appear  warranted due to the  water pollution control costs in general.
-  One plant representative has reported that a land disposal system is
   under construction-and his plant will soon discontinue its municipal
   treatment service. Since the proposed guidelines have not been
   promulgated, there is still uncertainty about the adequacy of this
   development and/or any requisite changes.

                                VI-15

-------
Table VI-8.  Percent price increase required to pay for incremental
             pollution control, wheat starch processing industry.
                      BPT              BAT               BAT
Size of Plant     Above Baseline    Above Baseline      Above BPT
Medium               8.7                8.9                .2
                              VI-16

-------
On the demand side, two major market demand questions arise (which
ultimately favor a further price increase as explained).  First, wheat
starch sales compete directly with corn starch products. Since corn
starch comprises  over ninety percent of all industrial starch sales in
the U.S., wheat starch prices cannot necessarily be  raised "as  needed."
Corn starch supplies (relative to demand) will essentially determine
industrial starch prices (including wheat starch).  In this respect,  only
about a 1 to 2 percent increase in starch prices may result  from increased
water treatment cost pass-throughs. _'

Secondly, vital wheat gluten market prices might be increased to recover
some or all of the anticipated higher waste treatment costs. In this case,
there is  a good market potential for recovering costs. Approximately half
of the value of sales from the wheat starch processing industry is derived
from vital wheat gluten products.   The demand for  gluten has  been growing
rapidly (not only in the baking industry but also in the manufacture of
texturized vegetable proteins).  Also, the U.S. has recently imported
about 40 percent of the U.S. demand for  gluten with steadily increasing
competition for available world supplies.  Further, the demand for vital
wheat gluten is regarded as price inelastic (no quantitative estimates of
price elasticity are known,  however); and, thus, these factors are favorable
from the wheat starch processing industry's viewpoint. —

While no definitive projection of average  potential price  increases  can
be made at this time,  the above factors suggest that a significant com-
posite price  change may be possible.  For example, an 8 to 10 percent
increase in gluten prices plus  a 1 to 2 percent change in starch prices
could result in a composite increase in sales of about 5 percnet.   Hence
a 3 to 5 percent overall price increase appears likely throughout the
industry based both on supply and demand factors.  Because of potential
supply shortages of gluten products for some time into the future,  a 5
percent target increase is  proposed for this analysis.

2.   Financial Effects

Two primary types of analyses were completed to assess the financial
impacts  of the proposed pollution control costs on the wheat starch model
plant: (1) profitability impacts and (2) impacts on the present value of
future net income  streams.
I/
—  A prior EPA study of the Corn Wet Milling industry indicated that
   corn starch price  increases  of this magnitude were expected due to
   water effluent controls.
2/
—  In contrast, the new wet processing methods  are principally designed
   to produce wheat gluten.  Over time adequate supplies of gluten may be
   more competitively produced in such plants.

                                VI-17

-------
Profitability impacts include the following:

       .   Pre-tax and after-tax
       .   After-tax return on sales
       .   Pre-tax and after-tax return on invested capital
       .   Annual cash flow

The two types of analyses were completed assuming no price increase
and with projected  1, 3 and 5 percent increases. L'  The 1 and 3 percent
price increase was examined to illustrate the sensitivity of price (revenue)
increases.  Expected impacts with a 5 percent price increase would result
in marginal plant operations for plants directly discharging.  Without such
a price increase model plants would be expected to close if the proposed
BPT and BAT treatment systems were required.

Pre-tax  and after-tax income
The impact of alternative effluent treatment levels on pre-tax net income
for the model wheat starch processing plant is illustrated in Table VI-9.
The imposition of BPT standards,  assuming no price increase, severely
reduces net income from $195, 000 to -$18,700.  The imposition of BAT
standards further reduces pre-tax income to -$29, 100.  As further shown
in Table VI-9. price increases of either 3 percent or 5 percent would re-
sult in positive pre-tax and after-tax incomes.  A 1  percent average price
(revenue) increase would lower losses, but not produce a positive net
inc om e.

Return on sales

The after-tax return on sales  for the model wheat starch plant, for al-
ternative treatment levels, is illustrated in Table VI-10.  The returns
follow the same general pattern as that established in the pre-tax income
situation. Profits are reduced by more than 100 percent with the impo-
sition of BAT and BPT standards.  After-tax  return on sales decline
from  3. 9 percent at baseline to -1.1 percent after the implementation
of BPT  and BAT standards with no price changes.  Again,  both 3 and 5
percent price increases would yield a  small positive return on sales as
is also shown in Table VI-10.
—  The 5 percent composite average price increase is projected.  Other
   composite price (sales) increases are shown to indicate sensitivity of
   impacts  due to price factors.
                               VI-18

-------
Table VI-9.  Pre-tax and after-tax income for model wheat starch
                 processing plant, with selected price changes
Size of Price . Pre-tax Income
Plant Increase— Baseline
/ O/ \
After -tax Income
BPT BAT Baseline
BPT BAT


Medium 0. 0
Medium 1. 0
Medium 3. 0
Medium 5. 0
195.0
221.0
272.7
324.5
-18.7 -29.1
7.3 -3.1
59.0 48.6
110.8 100.4
101.0
120.7
148.3
175.2
-18.7 -29.
5.7 -3.
37.2 31.
64.1 58.
1
1
8
7
—  Alternative price increases (assumed) reflect an average composite
   increase in both starch and gluten products such that sales revenue
   is increased by the percentage shown.  Three levels are shown to
   indicate sensitivity of results  to price changes.
                              VI- 19

-------
      Table VI-10.  Pre-tax and after-tax return on sales for model
                wheat starch plant, with selected price changes
Size of Price
Plant Increase _'

Medium 0. 0
Medium 1 . 0
Medium 3. 0
Medium 5. 0
Pre-tax Income After -tax Income
Baseline BPT BAT Baseline BPT BAT
__..__.._____ 	 	 _/%\ 	 	 	 _ 	 ..______._

7.5 -0.7 -1.1 3.9 -0.7 -1.1
8.4 0.3 -0.1 4.6 0.2 -0.1
10.2 2.2 1.8 5.6 1.4 1.2
11.9 4.1 3.7 6.4 2.4 2.2
—  Alternative price increases (assumed)  reflect an average composite
   increase in both starch and gluten products such that sales revenue
   is increased by the percentage shown.  Three levels are shown to
   indicate sensitivity of results to price changes.
                                VI-20

-------
Pre-tax and after-tax return on invested capital

Return on invested capital before and after taxes for the model wheat
starch processing plant is illustrated in Table VI-11.  After-tax income
as a percent of invested capital is 13. 1 percent.  With the imposition of
the BPT and BAT standards, after-tax return on invested capital de-
clines from 13.1 percent to  an estimated -1.7 percent.  Expected re-
turns on invested capital follow a similar pattern as the return on sales.
Returns on  invested capital after  price increases are also illustrated
in Table VI-11.  • In general, none of the price assumptions  shown would
return the plant to the same  profit level as indicated for the baseline case
without a price change.
Cash flow
Estimated cash flow (after-tax income plus depreciation) for the model
wheat starch plant is illustrated in Table VI-12.  Cash flow, at baseline,
is 17..8 percent.  The estimated cash flow  is adversely affected after the
imposition of the  BPT and BAT standards.  A 5% price increase returns
estimated cash flow to a level only slightly higher than attainable at base-
line with  no price increase.

Net present value (NPV)

Another measure  of financial viability of a plant is the net present value
(NPV) of  projected streams of cost and revenues.  Using this analysis,
it is possible to assess  the likelihood of continued plant operation versus
plant closure.   In discounting the cash flow using a discount rate  equivalent
to the firms  cost  of capital, positive NPV's would indicate the likelihood
of continued  plant operation whereas negative NPV's would infer a probable
plant closure.   To complete this analysis, the following assumptions were
made:

        1.  The existing plants have sunk investments but they could be
            disposed of  today for a salvage value and reinvested else-
            where if their wheat starch processing function were dis-
            continued.  However,  only  10 percent of the estimated
            replacement cost is  assumed recoverable for this industry.
            The relatively low value is  estimated because wheat starch
            processing plants are  moderately capital intensive and equip-
            ment  would  have little salvage value  in alternative uses  out-
            side the industry. Also,  most existing wheat starch  plants
            are relatively old.

        2.  Revenues and expenses are assumed to remain constant
            overtime, i.e., 20 years of operation.

                                VI-21

-------
Table VI- 11. Pre-tax and after-tax rate of return as a percent of average
              invested capital for model wheat starch processing plants,
                          with selected price changes.
Size of Price
Plant Increase

Medium 0.0
Medium 1 . 0
Medium 3. 0
Medium 5. 0
, Pre-tax Income After -tax Income
— Baseline BPT BAT Baseline BPT BAT
. 	 . 	 /%\ 	 _-__«_

25.3 -1.1 -1.7 13.1 -1.1 -1.7
28.7 0.4 -0.2 15.7 0.3 -0.2
35.4 3.4 2.7 19.3 2.1 1.8
42.1 6.4 5.7 22.8 3.7 3.3
—  Alternative price increases (assumed) reflect an average composite
   increase in both starch and gluten products  such that sales revenue
   is increased by the percentage  shown.  Three levels are shown to
   indicate sensitivity of results to price changes.
                               VI-22

-------
Table VI-12.  Estimated cash flow on average invested capital for
              model wheat processing plant,  alternative effluent
              treatment levels, assuming no price change.
Size of Plant         Baseline            BPT             BAT
                 ($000)    (%)       ($000)    (%)    ($000)

Medium          137       17.8       65      8.5      56      7.4
                               VI-23

-------
       3.  The estimated average cost of capital for the industry is
           9.0 percent.  The net present value of model wheat starch
           plants,  before and after the imposition of alternative
           effluent treatment standards, is illustrated in Table VI-13.

The imposition of BPT and BAT controls reduces the net present value
of the model wheat  starch to a negative position in all cases below the
5% price increase case.   This suggests that this size of plant would
not be able to bear  the cost of BPT and BAT controls and would prob-
ably shut down  unless prices increased by about 5 percent.  Variations
from the model plant case are obviously expected iu actuality, but the
analysis illustrates the general level of impacts and the sensitivity of
price (cost) pass throughs which  could affect a plant closure decision.

3.  NSP5 Effects -

New source performance standards (NSPS) equal to BPT and BAT stand-
ards as presented above, would apply to any new plant which had a point-
source discharge.  To assess probable impacts on such a plant, analysis
is first made of the model plant as described above--but with replace-
ment investment costs vs. book value investment  levels as was applied
to an existing model plant.

In brief, a new plant (using prevalent  technology)  would incur even
greater losses  than an existing plant because of its  higher average in-
vestment levels — unless prices were significantly increased.  The main
analytical question  involves an NPV analysis, i.e.,  would the NPV of a
new source be  equal to or greater than zero?  As shown in Table VI-14,
the answer is clearly no, assuming no price increases.

Other related questions are whether a new source would likely be con-
structed with increased prices; and if so,  at what increased level?
Further NPV analysis,  as is also summarized in Table VI-14,  suggests
that a new  source would not be economically viable even at the  5  percent
price increase level.  Extrapolation of the data shown indicates that
about an 8  percent price increase would be required to attract new plants
(using existing, prevalent technology) into the industry.

As was indicated earlier,  improved technology has been developed in the
wheat starch-gluten industry.  Hence, some question exists as to the
likelihood of new sources using prevalent technology.  If prevalent tech-
nology is not used,  then proposed NSPS standards may not be a strict
barrier to entry into the industry.
 !_/ To assess  NSPS effects, estimated pollution control capital and oper-
   ating costs as shown for BPT and BAT above were applied (in 1977 and
   1983  respectively) to approximate NSPS control costs.

-------
 Table VI- 13.  Net present values of model wheat starch processing
               plant before and after the imposition of alternative
               effluent treatment standards, with selected price
                                  changes

Size of Price
Plant Increase

Medium 0.0
Medium 1 . 0
Medium 3, 0
Medium 5. 0

BPT BAT
NPV ot NPV of NPV of NPV of NPV of
j^lant Before BPT plant After BAT Plant After
i— Controls Controls Controls Controls Controls
>_._____.__ 	 	 /
-------
Table VI-14. Net present value analysis of a new source model wheat
              starch processing plant before and after the imposition
              of alternative effluent treatment  standards, with selected
                                 price changes  _'
Plant
 Size
 Price
   NPV of
Plant Before
Increase—'   Controls
                                           BPT
                                                       BAT
 NPV of     NPV of     NPV of     NPV of
  BPT    Plant After     BAT    Plant After
 Controls    Controls  Controls     Controls
---	($000)			
Medium
Medium
Medium
Medium
0.
1.
3.
5.
0
0
0
0
368. 1
491. 5
763. 9
982.8
-1
-1
-1
-1
355.
355.
355.
355.
5
5
5
5
-987.
-864.
-618.
-372.
4
0
5
7
-33.
-33.
-33.
-33.
7
7
7
7
-1021. 1
-897. 7
-652. 2
-406. 3
— NPV analysis utilizing replacement cost investments,  and a 9% average
   cost of capital.   BPT and BAT control requirements equal to the exist-
   ing plant proposed standards.

—  Alternative price increases (assumed)  reflect an average composite
   increase in both  starch and  gluten products such that sales revenue
   is  increased by the percentage shown.  Three levels are shown to
   indicate sensitivity of results  to price changes.
                               VI-26

-------
No definitive answer can yet be made concerning the latter issues,
but the following summary of prospective conditons  in the industry is
presented as a guide to possible further impacts of the proposed guide-
lines.

Presently, two new wheat starch-gluten plants are under construction.
Both  have introduced improved technologies (wet processing techniques
with patents pending) that are anticipated to substantially reduce water
usage and waste  flows.  One plant will have a capacity comparable to a
2, 000 cwt/day plant (although it is not strictly comparable because of
different  raw  material inputs and waste flow characteristics); the second
plant is a pilot plant only.

Both  plants are  expected to come on-stream in the near future, and only
then will valid operating  data become available to the firms.  Thus,  it is
not yet possible to ascertain future aggregate production and marketing
impacts of the plants on existing markets (especially gluten markets).
It is known, however, that preliminary feasibility studies for the con-
struction  of additional plants by these firms are underway. Final studies
would presumably be completed following a trial period  of actual oper-
ations in the first plants.

4.  Other Effects

The remaining point-source related types of impacts--production effects,
employment effects, community effects and balance-of-payment effects--
are considered minimal due to the nature of this industry.  Six  of the seven
existing plants are not affected directly by the guidelines of this study;
although it is'noted that these plants are expected to incur an increase in
the cost of operation due  to increased surcharges from their respective
municipal plants.  Industry reactions to prospective changes in treatment
charges are varied, but price increases,  especially for gluten, are ex-
pected.
              t
Two other whet^t starch plants examined by DPRA for this study, both
of which have  $scontinued operation, were Colorado Milling and Elevator
Company  and  Hercules,  Incorporated. The Hercules plant processed
wheat starch for use in making other Hercules products.  It discontinued
operation due  to  location problems and state and local effluent guidelines
constraints (Hercules was dumping into a near-by lake).  The Colorado
firm was  not available for direct  information concerning their closing.
                                VI-27

-------
                     VII.  LIMITS OF THE ANALYSIS
The foregoing impact analysis was based upon data and information from
industry sources,  from published secondary data sources, and from sub-
jective judgment.  At various stages, the data utilized are subject to error.

The nature and scope of possible errors should be identified and limits
placed on the analysis accordingly.  The purpose of this final section is
to present limits of the analysis in terms of accuracy,  range of error and
critical assumptions.
                          General Accuracy
Financial information concerned with investments, operating costs and
revenues was in general not available for individual plants or firms in
the cereal and wheat  starch processing industries.  Consequently, the
financial aspects of the impact analysis were,  of necessity,  based upon
synthesized costs and returns for "representative" model plants w thin
each subindustry studied.  The accuracy of the financial data used is
difficult to measure,  however, it is believed that the data used are
representative.   Various checks were made to establish the reasonableness
of the data used.

The requisite data were developed by DPRA from a variety of sources
including published materials from universities and government agencies,
previous studies done by DPRA,  information obtained from industry
sources including trade associations, published financial performance
data sources, and from private individuals knowledgeable of the industry.
A variety of crosschecks were made using published information from the
Internal Revenue Service,  Standard and Poors. Dun and Bradstreet and
other financial data sources to ascertain whether the simulated perform-
ance experienced in the respective industries.  Based on these crosschecks,
it is believed that the model plants are  representative and suitable for
assessing the incremental impacts of pollution controls.

It is noted that in the  recent past the grain commodity markets in  general
(including corn, wheat and rice) have be->n exceptionally volatile and
record high prices have been  established.   These prices directly affect
the cereal and wheat  starch processing industries and the full reper-
cussions on these industries are not yet known.
                              VII-1

-------
Water pollution control costs, were provided by EPA (and Sverdrup &
Parcel and Associates),  These data were developed for typical plants
within each subindustry studied.  DPRA adjusted or scaled these data
as described above to reflect the  general price level changes but there
may be  considerable inaccuracy involved.

However, given the  accuracy of the r Dilution control costs to be accept-
able, it is believed that Mie analysis represents a usefully accurate
evaluation of the economic impact of the proposed effluent guidelines on
the cereal and wheat ctar;-h  processing industries as they currently exist.

1.  Errors in Data
Estimated data error lariges as. an average for the industry are as follows:

                                                         Error Range
        1.   Information regarding the organization
            and structure of Jbe industry, number,
            location, and size of plants,  and other
            information descriptive of industry segments       +  5

        2.   Price information of products and raw
            materials                                         +_ 20

        3.   Cost information for plant investments and
            opeiating coats                                    +_ 15

        4.   Financial information concerning the
            industries                                         +_ 1 5

        5.   Salvage values  of plants and equipment             +_ 20

        6.   Water pollution control costs               "      Unknown

        7.   Plant closxires                                     +_   5


                           Critical Assumptions
 In order to complete this analysis of the industries within the scope of
 study established, a variety of assumptions were required.   Some  critical
 assumptions were applicable to;:il segments  studied, while others-were
 specific to a given subir.dustry.  The main assumptions deserving further
 comment are described below.

                                   VII-2

-------
Representativeness  of Model Plants.  It is difficult to represent an industry
or subindustry with  only 1 to 3 model plant situations when there are
actually many sizes and types of plants in the industry.  In the industries
studied, the most difficult one to simply  represent was the ready-to-eat
cereal industry.   No two plants in this industry are alike because numer-
ous end-products  and product mixes can be produced.  The  smaller plants
in the industry may  not be adequately represented.

Model Plant Cost  Data.  Secondary or published investment and operating
cost data are minimal in the cereal and wheat starch industry.  Engineer-
ing synthesis techniques had to be relied upon as a basis for constructing
most of the model plant  cost data.   Piecemeal published data and informa-
tion provided by knowledgeable industry sources  were correlated with the
engineering data.  The resulting model plant data are believed reasonable
and representative,  but  it remains that the data are not based on detailed
"book value" statistics.

Prices  and Inflation.  Because of the tremendous variability in product
prices during the  past year, we felt that  1973 was atypical.   Since we did
not have sufficient information to construct a profile over time for the
operation of the industry,  1972 was taken as a more "normal" year.  As •
a result, we based our "model" plant financial profiles on that year.

Regarding  the impact of inflation on the model plant analyses, it is
commonly  assumed  that both costs and returns will be proportionately
affected by inflation such that the impact is offsetting.  However,  it is
noted that pollution control costs are increasing relatively faster than
other segments of the economy.  Thus,  one might question the accuracy
of the estimated 1977 and  1983 waste treatment costs relative to other
costs and prices.

Cost of Capital

The projected economic outlook for the U.  S. economy is fraught with
rising inflation, raw material shortages,  market uncertainties, etc.
Such factors contribute to upward pressures on the cost of debt and
equity capital.  A  9. 0 percent average cost of capital rate was estimated
as being most applicable throughout this  report.  However,  both higher
(11.0 percent) and lower (7.5 percent) rates were evaluated  in a sensi-
tivity analysis  of this factor, especially for the wheat starch processing
segment.   A lower rate  used in the  NPV analysis  reduces the likelihood
of plant closure based on the criterion used; a higher rate increases the
likelihood  of plant closure following the imposition of controls.  For ex-
ample,  financing of  wheat starch BAT control costs at 7. 5,   9.0 and 11.0
percent costs  of capital  results in NPV's for the  baseline model plant are
as shown in Table VII-1.  Also shown are the NPV's with selected price
changes of 1,  3 and  5 percent as were described  in Chapter VI.

                               VII-3

-------
A further sensitivity analysis involving both the cost of capital assumptions
and the price assumptions for an existing model wheat starch plant is as
summarized in Table VII-2.  In this case, the net present values of an
existing model plant are positive with a 5 percent price increase at both
the 7.5 and 9.0 percent cost of capital rates.  In other words,  an existing
plant would likely remain in operation if either it was forced off a munici-
pal system or plant management chose to build a private  treatment system
However, with less than about a 5 percent average price  increase,  plant
closure would be expected based on the analysis herein.
     B.   Current State of Waste Water Treatment in the Industry
Data on waste water treatment in the industry was obtained from the
Development Document and utilized as reported therein.

Salvage Values

Salvage values of buildings, equipment and land will vary greatly from
one location to another and with the type and condition of structures and
equipment.

In. order to avoid problems which would be inherent in attempting to
establish differential salvage values, a set  of 'rstandardtr assumptions
concerning salvage values  was developed.

       a.   Land was  salvaged at its 1972 value.
       b.   Buildings  and equipment for conventional plants were
            salvaged at a net amount equivalent to 10 percent of
            their 1972  replacement value.
       c.   Net operating capital was recovered intact.

Water Pollution  Control Costs

Data on water pollution control costs were supplied to DPRA by the
Effluent Guidelines Division of EPA.  We are not in a position to evaluate
these costs but they were assumed to be accurate. A question does arise
regarding the applicability of the  treatment  facility requirements (and
costs)  as they relate to new sources using the wet  processing technology.
Waste  flows are  presumably to be significantly reduced, and waste flow
characteristics will probably differ from those sampled by S &t  P as
reported in the Development Document.  This further raises a question
as to the appropriateness  of the BOD and SS guidelines as proposed.
                               VII-4

-------
Table VTI-1.  Net present value sensitivity analysis for a new source
              wheat starch processing plant, BAT standards, with
              selected costs of capital and selected price changes
Plant Size

Medium
Medium
Medium
Medium
Net Present Values -NSPS (BAT controls)
Price Cost of Capital
Increase 7.5% 9-0% 11.0%

0.0 -869-1 -1021.1 -1178.9
1.0 -731.2 -897.7 -1071.2
3.0 -457.2 -652.2 -857.2
5.0 -182.6 -406.3 -642.7
—  Alternative price increases (assumed) reflect an average composite
   increase in both starch and gluten products such that sales  revenue
   is increased by the percentage shown.  Three levels are shown to
   indicate sensitivity of results to price changes.
                              VII-5

-------
Table VII-2.  Net present value sensitivity analysis for an existing
          wheat starch processing plant, BAT with selected
            costs of capital and selected price changes
Plant Size
Medium
Medium
Medium
Medium
Price 1 ,
Increase —
0.0
1.0
3.0
5.0'
Net Present Values -Existing Plant (BAT controls)
Cost of Capital
7.%% 9.0% 11.0%
(* )
-471.5 -593.8 -723.
-333.6 -470.4 -615.
-59.6 -225.0 -401.
215.0 20.9 -187.

4
7
6
1
—  Alternative price increases (assumed) reflect an average composite
   increase in both starch and gluten products such that sales  revenue
   is increased by the percentage shown.  Three levels are shown to
   indicate sensitivity of results to price changes.
                               VII-6

-------
i  SHEET	|   EPA 230/1-74-03!:         T
   Ti.le jnj Subtitle
   Economic Analysis of Proposed Effluent Guidelines for Animal
    Feed,  Breakfast Cereal and Wheat Starch Segments of the
    Grain  Mills Point Source Category
                                           5. Repocc Date
                                              August,  1974
 7. Awhor(s)
                                                                     8. Performing Organization Kept.
                                                                       No.
 9- Performing Organization, Name and Address
    Development Planning and Research Associates, Inc.
    P. O.  Box 747,  200 Research Drive
                                           10. Project/Task/ttorlc Unit No.
                                              Task Order No.  13
    Ma ihattan, Kansas
6502
11. Contract/Grant No.
  Contra ct I\o.
  68-01-1: 33
 12. Sponsoring Organization Name and Address
    Environmental Protection Agency
    Waterside Mall
    4tn and M Strasts,  S.W.
    Wa '-ington. D. C.   20460
                                           13. Type or Repott i Period
                                              Covered
                                                  1 Report
                                           14.
 15. Supplementary .Voces
 16.
   ". JSfacts.
          T!:e  economic impacts  of proposed effluent limitations guidelines on three seg-
    ments of the grain milling industry were assessed: animal feed (SIC 2042) breakfast
    cereal (2043) and wheat starch-gluten (2046) processing.   The analysis included classi-
    fication and description of types of firms and plants,  evaluation of pricing mechanisms
    and relationships and financial profiles  of selected model plants.  Financial impacts
    of proposed effluent treatment tecunology were assessed in terms of price,  industry
    returns, and  production volume.  Employment, community impact and international
    trade effects  were also assessed.  Limits of the analysis were stated.
          Overall,  the proposed controls of this  study  (point source category only) will
    neither directly nor seriously impact the three segments  studied in the short  run.
    Water effluent problems of the animal feed segment are inconsequential and detailed
    assessments  were not required.   Virtually ail breakfast cereal and wheat starch
   Key Uords ano Document Analysis.  17o. Descriptors                                                —~~
    Water pollution,  economic analysis, economics, animal feed,  breakfast cereal,
    wheat starch, vital wheat gluten,  food,  pollution,  industrial wastes ,  demand,  supply,
    prices,  variable costs, fixed costs,  fixed investment, discounted cash flow.
17b. Idcntifiers/Open-Endej Terms     02 Agriculture,   B - Agriculture economics
                             05 Behavioral and Social Sciences,  C - economics
17c. COMTI Fit IJ/r.f ,up

• '• U Ji. JMuty it jttr.ii.-nt
                                                         IV. >Ck^f'!\.
                                                           Kef >rt i
                                                        -, - -'-
                                                        20. .Vv ura >  < ,.i •..-, j t u,i
                                                     21. t-.j.
                                                                                  120

-------
16.  Abstracts (continued)

processing plants are connected to municipal treatment systems and this
minimizes applicability of the proposed guidelines.  The breakfast cereal
industry is sufficiently viable to withstand proposed costs for pollution
control facilities if required.  However, the potential impacts of the
guidelines on the wheat starch segment are such that new entrants into
the industry would not be expected if private treatment systems were
required.  The industry growth prospects for the wheat starch processing
segment are  thus  uncertain.

-------